Unit 2 Chapter F:6 LO2 (Part 2)

Determining Merchandise Inventory Costs Under a Perpetual Inventory System

Overview of Inventory Costing Methods

• In this lesson, two new inventory costing methods are introduced:
  • Last In, First Out (LIFO)
  • Weighted Average Method
• The earlier lesson covered:
  • Specific Identification Method
  • First In, First Out (FIFO)

Last In, First Out (LIFO) Method

• Definition:
  • The LIFO method assumes that the latest costs added to inventory are the first ones to be sold, thus the oldest costs remain in ending inventory.
• Inventory Flow:
  • When goods are sold, they are subtracted from the most recent purchases first.
• Example:
  • SmartTouch Learning's purchases:
  • January 1: 3 tablets at $300 each
  • January 15: 3 tablets at $310 each
  • February 8: 3 tablets at $320 each
  • Sale on February 25: 3 tablets
  • According to LIFO:
  • Cost of Goods Sold (COGS) = Cost of the last purchased tablets
    • Calculation:
    • Sold 3 tablets at $320:
      ext{COGS} = 3 imes 320 = 960
  • Ending Inventory:
    • Remaining oldest costs still in inventory result in a total of:
      ext{Ending Inventory} = (3 imes 300 + 3 imes 310) = 1,830

Financial Statement Implications Under LIFO

• For the example in August:
  • Beginning Inventory: 2 units at $350 each for a total cost of $700
  • August 5 Purchase: 4 units at $360 each for a total cost of $1,440
  • Total Cost of Inventory on Hand after purchase:
    ext{Total Cost} = 700 + 1,440 = 2,140
  • Sale on August 15 of 4 units:
  • Sold units taken from the recent purchase of $360 each:
    • Results in:
      ext{Ending Inventory} = 2 imes 350 = 700
  • Purchase on August 26: 12 units at $380 each for a total cost of $4,560
  • Total Cost of Inventory on Hand:
    ext{Total Cost} = 700 + 4,560 = 5,260
  • Sale on August 31 of 10 units:
  • Goods taken from last purchase, $380 each:
    ext{COGS} = 10 imes 380 = 3,800
  • Ending Inventory after sales:
  • 2 units from beginning inventory
  • 2 units from previous purchase:
    • Total:
      ext{Total} = (2 imes 350) + (2 imes 380) = 1,460
• Summary for August:
  • Total Purchases: 6,000
  • Total COGS: 5,240
  • Ending Inventory: 1,460

Journal Entries Under LIFO

• June Transactions:

1. Beginning Inventory: $700
2. Purchases:
   • August 5: 1,440
   • August 26: 4,560
3. Sales (last in first out):
   • August 15: 4 units sold =>
     • COGS calculated on recent purchase:
       ext{COGS} = 4 imes 360 = 1,440
   • August 31: 10 units sold =>
     • COGS calculated on recent purchase:
       ext{COGS} = 10 imes 380 = 3,800

Weighted Average Method

• Definition:
  • This method calculates a weighted average cost per unit of inventory after each purchase, utilized for determining COGS and ending inventory.
• Calculation of Weighted Average Cost:
  • The weighted average cost per unit formula is:
    ext{Weighted Average Cost} = rac{ ext{Total Cost of Goods Available for Sale}}{ ext{Total Units Available for Sale}}
• Example with SmartTouch Learning:
  • Beginning Inventory: 2 units at $350 each = $700
  • August 5 Purchase: 4 units at $360 each
  • Total Cost After Purchase:
    700 + 1,440 = 2,140
  • Units Available = 6 units
  • Weighted Average Cost:
    ext{Weighted Average Cost} = rac{2,140}{6} = 356.67
  • August 15 Sale: 4 units sold
  • COGS:
    4 imes 356.67 = 1,427
  • Ending Inventory after Sale: 2 units
  • Cost:
    2 imes 356.67 = 713
  • August 26 Purchase: 12 units at $380 each
  • New Total Cost:
    713 + 4,560 = 5,273
  • Unit Calculation for Weighted Average Cost:
  • New Weighted Average:
    ext{Weighted Average Cost} = rac{5,273}{18} = 376.64
  • August 31 Sale: 10 units sold:
  • COGS:
    10 imes 376.64 = 3,766
• Summary for August:
  • Purchases: 6,000
  • COGS: 5,193
  • Total Inventory on Hand: 1,507

Financial Statement Impact Under Weighted Average Method

• Ending inventory is reflected in the balance sheet:
  • 4 units remaining at the weighted average cost = $1,507
• Overall cost of goods available for sale maintained across all methods:
  • Total = 6,700
  • Ending Inventory + COGS should equal the total:
    1,507 + 5,193 = 6,700

Journal Entries Under Weighted Average Method

• Journal entries are consistent across weighted average, LIFO, and FIFO for the initial purchases.
• Differences arise only in the last entry:
  • For August 15 sale:
    ext{COGS} = 1,427
  • For August 31 sale:
    ext{COGS} = 3,766

Conclusion

• The methods of LIFO and weighted average each impact inventory costs, COGS, and financial statements differently, but the total cost of goods available for sale remains constant across all methods.