Inventory Valuation

INVENTORY VALUATION: SPECIFIC IDENTIFICATION FIFO LIFO WEIGHTED AVERAGE MOVING AVERAGE SPECIFIC IDENTIFICATION FOR EXAMPLE! The costs of individual inventories are not interchangeable. Specific good has its specific cost using specific identification of their individual costs. This method tracks each inventory and assign cost individually Instead of grouping inventories together. It is usually used when inventories are small in numbers. Therefore, it is appropriate for companies that sell cars or Real estate. XYC Company, a car dealership company, has 5 cars on the lot. A Lamborghini worth $2 million, a Porsche worth $114,000, a Ferrari worth $575,000, a BMW worth $100,000 and a Ford Mustang worth $50,000. Each car is tracked individually from the time they are purchased until they are sold. The company must know what they paid for its purchase cost and each item left. Illustrative Example: TRANSACTION: A rich buyer bought 2 (two) cars in XYZ Company. The company sold the Lamborghini and Ford mustang for an amount of $2.5 million and $80,000, respectively. What is the ending inventory? What is the cost of sale? What is the gross revenue? What is the net sales? Lamborghini $ 2 million Porsche $ 114,000 Ferrari $ 575,000 BMW $ 100,000 Ford Mustang $ 50,000 ANSWER! If Lamborghini and Ford Mustang was sold, then the ending inventory will be the Porsche, Ferrari and BMW amounting to $789,000. The cost of sale is the value of inventory sold which is Lamborghini $2 million and Ford Mustang $50,000. The gross revenue means how much did the seller sold the car. Lamborghini was sold for $2.5 million and Ford mustang was sold for $80,000. Therefore, the net sales for Lamborghini is $500,000 ($2.5million less $2million) while the net sales for Ford mustang is $30,000 ($80,000 less $50,000). FIRST-IN FIRST-OUT (FIFO) EXAMPLE TRANSACTION: ABC Retailer is selling sacks of rice. It has 10 sacks of rice in January with cost of $20 per sack. The owner purchased another 20 sacks of rice for $25 per sack, in anticipation of more sales. The first inventory purchased is the first inventory to be sold – “First-in; First-out”. In other words, assets acquired first are sold first. Inventories sold was the oldest item purchased, therefore, remaining Inventories are those recently purchased. This method results to more accurate measurement of Of cost flow than LIFO and Weighted-Average Method. During the month of February, a customer bought 18 sacks of rice. In preparation for next sales, ABC Retailer purchased another 15 sacks of rice for $30 per sack for the month of March. During January, the Total Goods available for sale is 30 sacks (10 sacks from beginning inventory and 20 sacks for its January purchase). The amount of inventory ABC Retailer is holding amounts to $700. 10 SACKS 20 SACKS $ 20 per sack Beginning Inventory $ 25 per sack Purchase (10 Sacks multiply by $20 per sack equals $200) (20 Sacks multiply by $25 per sack equals $500) During February, 18 sacks of rice were sold. The 18 sacks, for purpose of costing, is composed of 10 sacks from Beginning inventory with cost of $20 per sack and 8 sacks from Purchases with cost of $25 per sack. Remember the First-in, First-out system. Exhaust first the Beginning inventory before selling the inventories under purchases. Therefore, the cost of goods sold is $400. (10 sacks x $20 = $200) 10 SACKS 20 SACKS $ 20 per sack Beginning Inventory $ 25 per sack Purchase (8 sacks x $25) = $200) After sales, there are remaining inventories which we usually call “Ending Inventory”. Take note that this ending inventory is only for the month of February. There are 12 sacks of rice which is not yet sold. These are the remaining inventories (Ending inventory) for the month of February. These remaining inventories costs $300 (12 sacks x $25). KEEP IN MIND! 10 SACKS $ 20 per sack Beginning Inventory 20 SACKS $ 25 per sack Purchase The ending inventory for the month of February is the beginning inventory for the month of March. If 12 sacks of rice is the ending inventory for February, then March beginning inventory is 12 sacks of rice Total cost of goods available for sale is $750. Breakdown: Ending inventory for February = $300 March purchases = $450 Had it been a customer bought another 2 sacks of rice during the month of March, ABC Retailer should sell first the Remaining inventories from February Inventories with a cost of $25 per sack and then start selling March purchases with cost of $30 per sack if the inventories from February are already exhausted. REMAINING INVENTORIES FROM FEBRUARY INVENTORIES These are the 12 sacks of rice not yet sold by ABC Retailer during the month of February. In other words, this is the ending inventory for the month of February. The cost of which is $300 (12 sacks x 25 per sack) IN PREPARATION FOR NEXT SALES, ABC retailer PURCHASES ANOTHER 15 SACKS The company purchased another 15 sacks with cost of $30 per sack. Therefore, the total cost of purchase for the month of March is $450 (15 sacks x $30 per sack) NOTICE! Unlike Specific Identification, First-in First-Out method is based on Cost Flow assumption (the manner in which costs are removed from a company’s inventory and are reported as the Cost of Goods Sold) Specific identification method matches the actual historical costs of specific inventory items to their physical flow. FIFO sells the oldest inventory. Specific Identification allows seller to specify which inventory is sold. Example Problem: FIFO Method Purchases Date Units Unit Cost Total Cost January 1 January 6 January 15 January 20 100 $2.50 $250 300 2.75 825 200 3.00 600 500 2.50 1,250 Solution: On January 7, using the FIFO method, sold 250 units. Exhaust first the 100 units of January 1 Beginning inventory with unit cost of $2.50 before January 6 purchases. 100 units were sold from beginning inventory and 150 units were sold from January 6 purchases to complete the January 7 sales of 250 units. The remaining inventory for January 6 is 150 units. Under the FIFO method, exhaust first the remaining inventory of January 6 before selling the January 15 Purchases. Since January 16 Sales is only 50 units, the remaining inventory of January 6, which is 150 units is enough to complete the January 16 sales. The Cost of Goods sold for the month of January is $800 (COGS of January 7 is $662.5 plus COGS of January 16 is $137.5) Therefore, the ending inventory for the month of January would be 800 with a Total cost of $2,125. LAST-IN FIRST-OUT (LIFO) EXAMPLE TRANSACTION: This is the opposite of First-in, First-out method. The last inventory purchased is the first inventory to be sold – “Last-in; First-out”. In other words, assets acquired last are sold first. Inventories sold are the newest item purchased, therefore, remaining Inventories are those oldest purchased. XYZ retailer is selling school supplies, of which it uses the LIFO method for its inventories of ballpen. During the first month of the year, it has 20 ballpens with a cost of $1 per ballpen. A customer bought 3 ballpens during the same month. The following month, February, XYZ retailer purchased 5 Ballpens with cost of $1.50 per ballpen. A customer bought 7 ballpens. JANUARY INVENTORY During first month, the beginning inventory is 20 Ballpens with cost of $1 per ballpen, which means Total cost of inventory is $20. (20 Ballpens x $1 per ballpen) Currently, these 20 ballpens are the newest inventories of XYZ retailer. 20 BALLPENS ($1 per ballpen) Therefore, if a customer bought 3 ballpens, XYZ retailer’s cost of goods sold is $3 (3ballpens x $1 per ballpen) for the first month of the year. JANUARY REMAINING INVENTORY FEBRUARY INVENTORY During February, the beginning inventory is 17 Ballpens ($1 each ballpen) and there are purchases of another 5 ballpens ($1.50 each ballpen). 5 BALLPENS ($1.50 per ballpen) Therefore, the total inventories available for sale would be 22 Ballpens. 17 BALLPENS ($1 per ballpen) During February, whenever XYZ Retailer sell inventories using LIFO inventory system, the most recent purchases should be sold first. 5 BALLPENS ($1.50 per ballpen) 17 BALLPENS ($1 per ballpen) The most recent purchase is the 5 Ballpens. Therefore, the cost of goods sold should be $9.5. (5 Ballpens x $1.50 per ballpen = $7.5) (2 Ballpens x $1 per ballpen = $2) The ending inventory is 15 Ballpens with a total cost of $15. Example Problem: LIFO Method Purchases Date Units Unit Cost Total Cost January 1 January 6 January 15 January 20 100 $2.50 $250 300 2.75 825 200 3.00 600 500 2.50 1,250 Solution: Under the LIFO Method, Selling 250 units would mean exhaust first the newest purchase, which is January 6 in this case, before selling the inventories of January 1 (Beginning Inventory). January 6 inventories were reduced by 250 units because of the January 7 sales. The January 16 sale will come from the purchase of January 15 because it is the most recent purchase. Under the LIFO method, sell first the newest purchases before selling the older inventories. The ending inventory therefore will be computed as follows. FIFO DURING INFLATION “INFLATION measures how much more expensive a set of goods and services has become over a certain period”. INVENTORY - International Monetary Fund OLD NEW CONCEPT OF FIFO Sell first the oldest purchased inventories before selling the newly purchased inventories. During Inflation, FIFO will result in higher immediate profit margins Selling Price Less: Cost of Inventory Sold Gross Profit The cost of older goods is cheaper than the cost of newer goods. Therefore, selling older goods first will result in a higher Gross profit. LIFO DURING INFLATION “INFLATION measures how much more expensive a set of goods and services has become over a certain period”. INVENTORY - International Monetary Fund OLD NEW CONCEPT OF LIFO Sell first the newest purchased inventories before selling the older purchased inventories. During Inflation, LIFO will result in lower immediate profit margins Selling Price Less: Cost of Inventory Sold Gross Profit The cost of newer goods is more expensive than the cost of older goods. Therefore, selling newer goods first will result in a lower Gross profit. The current Cost of Inventory sold would be higher. WEIGHTED AVERAGE METHOD Illustrative Example: Calculates the average cost of all inventory available for sale over a respective period. Total goods available for Sale in amount Is divided by Total goods available for sale In units to get the Average cost of each Inventories. Unlike FIFO and LIFO that tracks the oldest and newest inventories purchased, the “Average cost” in Weighted Average Method is the cost of each inventory regardless of which inventory is purchased first or last. Total Goods available for sale =Beginning Inventory + Net Purchases The Total goods available for sale is composed the Beginning Inventory and Net Purchases Total GOODS AVAILABLE FOR SALE (in amounts): $140 Total GOODS AVAILABLE FOR SALE (in units): 5 units Average cost per unit = $28 ($ 140 ÷ 5 units) Therefore, if the seller sold 3 units of soccer ball, the cost of the goods sold would be $84. (computed as: 3 units x $28) and the cost of ending inventory is $56 (2 units x $28). SOLUTION: Example Problem: Total Cost of Goods Available for sale (in amount): $2,925 Total Cost of Goods Available for sale (in units): 1,100 Weighted Average Method Purchases Date January 1 January 6 January 15 January 20 Units Unit Cost Total Cost 100 $2.50 $250 300 2.75 825 200 3.00 600 500 2.50 1,250 Sales Date Units January 7 January 16 250 50 MOVING AVERAGE METHOD Illustrative Example: Beginning Inventory: This method recomputes the unit costs of the inventories every after acquisition or purchase of goods. It is a method for inventory valuation by which the unit cost is calculated every time Inventories are accepted instead of calculating the cost of inventory at the end of the month. If Weighted average method requires you to sum the Beginning balance and all the purchases for the period to compute for the Average cost per unit, the Moving average unit cost per unit changes every time you purchase. There are 3 units available for sale at the beginning of the period which costs $20 each. The total cost of inventory is $60. Suppose the company bought 2 more units at $40 per unit, then the total cost of purchases is $80. Since there is a purchase, the cost of each inventory will be recomputed as follows: Total cost of beginning inventory $60 plus total cost of purchases $80 is divided by the total inventories available for sale, which is 5 units. Thus, the cost of each inventory after purchasing is $28 computed as (60+80) ÷ 5 Example Problem: Moving Average Method Purchases Date January 1 January 6 January 15 January 20 Units Unit Cost Total Cost 100 $2.50 $250 300 2.75 825 200 3.00 600 500 2.50 1,250 Sales Date Units January 7 January 16 250 50 SOLUTION: NOTICE !!! The cost of Goods sold are the units sold on January 7 and 16 which is 300 units with Total cost of $816. The ending inventory is 800 units with Total cost of $2,111. Notice that for every purchase of inventory, the Unit cost is recomputed.