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Inventory Costing Methods Explained

The document outlines the accounting treatment of inventory, including its capitalization as an asset, the transfer of costs to Cost of Goods Sold (COGS), and the calculation of gross profit. It explains different inventory costing methods such as FIFO, LIFO, and Average Cost, along with their financial statement effects and implications for gross profit margins. Additionally, it discusses metrics like inventory turnover, days inventory outstanding, and the cash conversion cycle, as well as the accounting for intangible assets and goodwill.

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20 views8 pages

Inventory Costing Methods Explained

The document outlines the accounting treatment of inventory, including its capitalization as an asset, the transfer of costs to Cost of Goods Sold (COGS), and the calculation of gross profit. It explains different inventory costing methods such as FIFO, LIFO, and Average Cost, along with their financial statement effects and implications for gross profit margins. Additionally, it discusses metrics like inventory turnover, days inventory outstanding, and the cash conversion cycle, as well as the accounting for intangible assets and goodwill.

Uploaded by

MarieJ29
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Module 6

Inventory:
 Is capitalized on the BS as an asset when it is purchased or
manufactured

Cost of Goods Sold (COGS):


 Inventory cost transferred from the balance sheet to the income
statement as an expense called COGS

Gross Profit:
 Sales (or Revenues) – COGS = Gross Profit

How the Income Statement reports COGS

How does the cost of Inventory move through the financial


statements?

FIFO Inventory Costing Method


 First-In, First-Out says that the earlier inventory costs (first-in) are the
first costs transferred from inventory (first-out)
 I.e., see graphics below:

Recording with FIFO Costing:

LIFO Inventory Costing Method:


 Last-In, First-Out says that the latest inventory costs (last-in) are the
first costs transferred from inventory (first-out)
 I.e., see graphics below:

Recording with LIFO Costing:

Average Cost (AC) Inventory Costing Method:


Module 6

 Average Cost method takes the average cost of all current inventory
and applies that as the unit cost
 Commonly adopted when inventory purchases and sales are
continuous throughout the year
 I.e., see graphics below:

Recording with AC Costing:

Financial Statement Effects of Inventory Costing

LIFO Reserve:
 The difference between FIFO and LIFO inventories

When inventory costs rise, LIFO yields lower NI – tax benefits

Lower of cost or market

Balance Sheet Adjustments for a LIFO Reserve:


Income Statement Adjustments for a LIFO Reserve:

LIFO Liquidation:
 The increase in gross profit resulting from a reduction of inventory
quantities in the presence of rising costs

Gross Profit Margin:


 Gross Profit / Sales

Factors that can adversely affect gross profit margins:

Inventory Turnover:
 Measures the number of times during the period that the company
sells its inventory
 Use COGS because inventory is reported at cost

Days Inventory Outstanding:


 Measures the days required to sell the average inventory available for
sale
Module 6

 AKA Average Days Inventory Outstanding

Accounts Payable Turnover (APT):


 The number of payment cycles in the year

Days Payable Outstanding (DPO):


 The average length of time a company takes to pay its suppliers

Cash Conversion Cycle:

Land is never depreciated as its useful life cannot be estimated


Valuation Models for Intangible Assets:
1. Relief from Royalty Method (RMM):
a.
2. Multiperiod Excess Earnings Method:
a.
3. With and Without Method:
a.
4. Real Option Pricing:
a.
5. Replacement Cost Method Less Obsolescence:
a.

Accounting for Goodwill


Module 6

Analysis of Intangible Asset Impairment Charges

Example:
 IS reported current year COGS of $2,852,714 thousand
 BS reported inventories of $1,019,496 thousand and $1,158,548
thousand for the current and prior years, respectively

The costs incurred during the current year, include the following:

Costs Recorded in Cost of Goods Sold ($ thousands) Current Year


Inventory write-offs $20,801
Total cost recorded in cost of goods sold $20,801

d. They had not written off inventory, what would it report for COGS? What
would have been the inventory balances in the current and prior years?
COGS: $2,831,913 (subtract write-off of $20,801 from
$2,851,714 on IS)
Current inventory: $1,040,297 (add write-off of $20,801 to $1,019,496
on BS)
Prior inventory: $1,158,548

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