Resources | Subject Notes | Accounting
Inventory, also known as stock, represents the value of goods held for sale in the normal course of business. Accurately valuing inventory is crucial for preparing a correct Statement of Financial Position (Balance Sheet) and Income Statement. There are two main methods for valuing inventory: FIFO and Weighted Average.
The FIFO method assumes that the first units purchased are the first units sold. This means the remaining inventory on hand is valued using the cost of the most recently purchased goods.
Example: If a company buys 100 units at $10 each on January 1st and 150 units at $12 each on February 1st, and sells 120 units in March, the cost of the 120 units sold would be calculated as follows:
- 100 units @ $10 = $1000
- 20 units @ $12 = $240
Total cost of goods sold = $1000 + $240 = $1240
Remaining inventory = 100 units (from January) + 30 units (from February) = 130 units
Value of remaining inventory = 130 units * $12 = $1560
The weighted average cost method calculates a weighted average cost for all inventory available for sale during a period. This average cost is then used to value both the cost of goods sold and the remaining inventory.
Formula:
$$ \text{Weighted Average Cost} = \frac{\text{Total Cost of Goods Available for Sale}}{\text{Total Units Available for Sale}} $$Example: A company has 100 units at $10 each and 200 units at $12 each available for sale.
Total cost of goods available for sale = (100 * $10) + (200 * $12) = $1000 + $2400 = $3400
Total units available for sale = 100 + 200 = 300 units
Weighted Average Cost = $3400 / 300 units = $11.33 per unit
If the company sells 150 units, the cost of goods sold is:
Cost of Goods Sold = 150 units * $11.33/unit = $1699.50
Remaining inventory = 150 units (from the first batch) + 100 units (from the second batch) = 250 units
Value of remaining inventory = 250 units * $11.33/unit = $2832.50
This statement shows the cost of goods sold and the value of the remaining inventory using the FIFO method.
| Description | Amount ($) |
|---|---|
| Beginning Inventory | $1000 |
| Purchases | $2400 |
| Goods Available for Sale | $3400 |
| Cost of Goods Sold | $1240 |
| Ending Inventory | $1560 |
This statement shows the cost of goods sold and the value of the remaining inventory using the weighted average cost method.
| Description | Amount ($) |
|---|---|
| Goods Available for Sale | $3400 |
| Cost of Goods Sold | $1699.50 |
| Ending Inventory | $2832.50 |
The choice of inventory valuation method can impact a company's profit and taxable income. Companies must consistently apply a chosen method from period to period. The most common methods are FIFO and Weighted Average. There are differences in the results of these methods, especially during periods of fluctuating prices.