ACG 2021 - CHAPTER 5 PERPETUAL INVENTORY SYSTEM A perpetual inventory system seeks to track inventory levels in real-time throughout the entire inventory cycle (purchase, storage, sale, replace). GAAP allows companies to choose from three different inventory cost flow methods to track these inventory amounts. First-In-First-Out (FIFO): Assumes that the oldest purchased inventory items are sold first. Last-In-First-Out (LIFO): Assumes that the newest purchased inventory items are sold first. Average Cost Method: Uses a weighted average cost calculation to determine COGS. Technically, there is a fourth method called "Specific Identification" that assumes that the company can easily identify exactly which items are being sold. When completing problems in this chapter, you must pay close attention to how the problem is constructed. For instance, some problems are setup like the one below where a beginning inventory level is given and then a series of inventory purchases throughout the month. These types of problems can easily be solved using a basic chart like the one shown below. Instructions: Use the information below to solve determine COGS and Ending Inventory for each of the 3 inventory methods (FIFO, LIFO and Avg. Cost). Start by just reviewing the FIFO completed example. Then, complete the LIFO problem on your own. EXERCISE ONE: The inventory records of Synergy Prosthetics indicate the following. DATE UNITS PER UNIT TOTAL July 1 July 8 Beg Inventory 6 units $60 $360 Purchase 5 units $67 335 July 15 Purchase 10 units $70 700 July 26 Purchase 5 units $85 425 AVAILABLE 26 units $1,820 FOR SALE On July 29th, Synergy sold 18 units at a sales price of $125 each. Compute Cost of Goods Sold and Ending Inventory using each of the following methods: FIFO, LIFO & Weighted Average Cost. First-in-First-Out (FIFO): Review completed example below. A B C AxC SOLD END INV PER UNIT COGS BxC END INV From July 1 6 units $60 $360 From July 8 5 units $67 335 From July 15 July 26 7 units 3 units $70 490 210 5 units $85 425 TOTAL 18 units 8 units $1,185 $ 635 Last-in-First-Out (LIFO): Complete non-shaded areas where necessary. TOTAL A SOLD B C AxC BxC END INV PER UNIT COGS END INV Weighted Average Cost: Review completed example below. AVERAGE COST $ COGS END INV Inventory Available for Sale $1,820 Divide by: Units Available for Sale 26 Average Cost $70 x 18 units. X 8 units TOTAL $1,260 $ 560 Next, using the data from the previous page, summarize the differences between the 3 inventory cost flow methods. Recall that the company sold 18 units at a sales price of $125 each on July 29 FIFO LIFO AVG COST Sales $ $ Less: COGS ( ) ) ( ) Gross Profit $ $ $ Ending Inventory $ $ $ Which method resulted in the highest gross profit amount? Why? FIFO. Because in this example, the inventory prices rose throughout the month. So, since FIFO assumes that the oldest purchase items are sold first, the lower prices for these items would flow to COGS and result in a smaller COGS number. We can then conclude that in an environment where prices are rising (inflationary) FIFO would result in a higher gross profit and also a higher ending inventory amount. Other problems in this chapter are constructed a little differently, so you must solve them differently. If the problem mixes both purchases and sales transactions throughout the period, a chart like the following should help to solve the problem. Review the example problem below. Then, complete the next problem on your own. EXERCISE TWO: Purchases and Sales The inventory records of Synergy Prosthetics indicate the following purchases and sales throughout July. DATE UNITS PER COST SALES UNIT July 1 Beg Inventory 6 units $60 $360 July 8 Purchase 5 units $67 335 July 10 Sales (7) units 875 July 15 Purchase 10 units $70 700 July 22 Sales (8) units 1,000 In control option command > B Review the example below on how to calculate Cost of Goods Sold and Ending Inventory using FIFC DATE UNITS PER UNIT COST COGS INV BALANCE July 1 Beg Inv. 6 units $60 $360 $360 July 8 Purchase 5 units $67 335 695 July 10 From July 1 (6) units 60 360 335 From July 8 (1) unit 67 67 268 July 15 Purchase 968 10 units $70 700 July 22 From July 8 (4) units 67 268 700 From July 15 (4) units 70 280 420 TOTAL 6 units $975 $420 Next, solve the same problem using the LIFO method (complete non-shaded areas as necessary): DATE UNITS PER UNIT COST COGS INV BALANCE TOTAL $ option command LOWER OF COST OR MARKET Per the Cost Principle, inventory is first recorded at its original cost. However, the Lower of Cost or Market rule dictates that the inventory asset be periodically evaluated to see if adjustments need to be made to comply with the Lower of Cost or Market (LCM) rule, Under this rule, Market Value is defined as "replacement cost". In other words, the cost to the company to replace the items as of the date this principle is being applied. Market value Replacement Cost INSTRUCTIONS: Review the following completed analysis for Turner Company as of December 31. Then, review the adjustment entry needed to comply with the LCM rule. A B C AxB AxC ITEM QTY COST MV PER TOTAL TOTAL LCM PER UNIT COST MKT UNIT x 20 $40 $42 $800 $840 $800 Y 15 38 35 570 525 525 Z 30 80 28 20 24 840 720 720 TOTAL $2,210 $2,085 $2,045 N The LCM rule can be applied individually or in aggregate. If the individual approach is used simply compare the current inventory asset amount to the LCM column on the far right. Then make an adjustment to both the asset and COGS if the LCM column is lower. Inventory COGS Bal. 2,210 165 165 LCM 2,045 If the LCM is applied to total inventory in aggregate, you would instead use the TOTAL MKT column for the adjustment. So, in this case the LCM would be $2.085 and the adjustment would be for $125 ($2.210 2,085 $125). NOTE: Once an adjustment has been made to reduce the inventory total, you cannot make an entry: to increase the inventory balance later, even if the market value increases. Also, an entry can never be made to record inventory above its original cost