6.1 Inventory Cost Flow Assumptions LO1 Calculate cost of goods sold and merchandise inventory using specific identi- fication, first in first-out (FIFO), and weighted average cost flow assumptions perpetual. Determining the cost of each unit of inventory, and thus the total cost of ending inventory on the balance sheet, can be challenging. Why? We know from Chapter 5 that the cost of inventory can be affected by dis- counts, returns, transportation costs, and shrinkage. Additionally, the pur- chase cost of an inventory item can be different from one purchase to the next. For example, the cost of coffee beans could be $5.00 a kilo in Octo- ber and $7.00 a kilo in November. Finally, some types of inventory flow into and out of the warehouse in a specific sequence, while others do not. For example, milk would need to be managed so that the oldest milk is sold first. In contrast, a car dealership has no control over which vehicles are sold because customers make specific choices based on what is avail- able. So how is the cost of a unit in merchandise inventory determined? There are several methods that can be used. Each method may result in a different cost, as described in the following sections. Assume a company sells only one product and uses the perpetual inventory system. It has no beginning inventory at June 1, 2015. The company purchased five units during June as shown in Figure 6.1. Date June 1 5 Price per unit $1 2 3 4 5 $15 Figure 6.1: June Purchases and Purchase Price per Unit Purchase Transaction 7 21 28 Number of units 1 1 1 1 1 5 At June 28, there are 5 units in inventory with a total cost of $15 ($1 + $2+ $3+ $4 + $5). Assume four units are sold June 30 for $10 each on account. The cost of the four units sold could be 6.1. Inventory Cost Flow Assumptions 217 determined based on identifying the cost associated with the specific units sold. For example, a car dealership tracks the cost of each vehicle purchased and sold. Alternatively, a business that sells perishable items would want the oldest units to move out of inventory first to minimize spoilage. Finally, if large quantities of low dollar value items are in inventory, such as pencils or hammers, an average cost might be used to calculate cost of goods sold. A business may choose one of three methods to calculate cost of goods and the resulting ending inventory based on an assumed flow

determined based on identifying the cost associated with the specific units sold. For example, a car dealership tracks the cost of each vehicle purchased and soid. Alternatively, a business that sells perishable ltens would want the oldest units to move out of inventory first to minimize spollage. Finally, if large quantities of low dollar value items are in inventory, such as penclis or hammers, an average cost might be used to calculate cost of goods sold. A business may choose one of three methods to calculate cost of goods and the resulting ending inventory based on an assumed flow. These methods are: specific identification, Fifo, and weighted average, and are discussed in the next rections. Specific Identification Under specific identification, each inventory item that is sold is matched with its purchase cost. This method is most practical when inventory consists of relatwely few, expensive items, particularly when individual units can be identified with serial numbers - for example, motor vehicles. Assume the four units sold on fune 30 are those purchased on June 1,5,7, and 28 . The fourth unit purchased on June 21 remains in ending inventory, Cost of goods sold would total $11 ( $1 * $2+$3+$5). Sales would total $40(4$10). As a result, sross profit would be $29($4011). Ending inventory would be $4, the cost of the unit purchased on June 21 . The general ledger T-accounts for Merchandise inventory and Cost of Goods Sold would show: 2 What is the FIFO Unit Price(s) to be used in valuing Ending Inventory? 6.1 Inventory Cost Flow Assumptions Determinine the cost of each unit of imventory, and thus the total cost of ending inventory on the balance sheet, cas be challenging Why? We know from Chapter 3 that the cost of inventory can be affected by dis: counts, returns, transportation costs, and shrinkage. Additionally, the purchase cost of an inventory item can be dfflerent from one purchase to the next. For example, the cost of coffee beans could be $5.00 a k. 610 in Octobet and $7.00 a kilo in November. Finally, some types of inventory flow into and out of the warehouse in a specific sequence, while others do not: For example, milk would need to be managed so that the oldest milk is sold fint. In contrast, a car dealership has no control over which vehicles ate sold because customers make specific cholces based on what is aval. able. So how is the cost of a unit in merchandise inventory determined? There are several methods that can be used. Each method may resuit in a different cost, as described in the followirg sections. Assume a company sells only one product and uses the perpetial imventory swatem. it has no beginning imentiory at lune 1, 2015. The company purchased tive units during June as shown in Finure 51 . Figure 6.1: June Purchases and Purchase Price per Unit A. June 28 , there are 5 units in inventory with a total cost or $15($1+$2+$3+$4+$5). Assume four units are told June 30 for $10 each on account. The cost of the four units sold could be determined based on identifyg the costassociated w th the specific units sold for crample, a car dealership tracks the cost of each vehicle purchased and sold, Aternatively, a business that sells perihhable items would want the oldest units to move out of invensory first to minimite spoilage. an avirage cost might be used to calculate cost of hoods rold, A business may choose one of three Thethods to calciale cost of goods and the resulting ending inventory based on an assumed flow