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:
        extCOGS=3imes320=960ext{COGS} = 3 imes 320 = 960
    • Ending Inventory:
      • Remaining oldest costs still in inventory result in a total of:
        extEndingInventory=(3imes300+3imes310)=1,830ext{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:
      extTotalCost=700+1,440=2,140ext{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:
        extEndingInventory=2imes350=700ext{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:
      extTotalCost=700+4,560=5,260ext{Total Cost} = 700 + 4,560 = 5,260
    • Sale on August 31 of 10 units:
    • Goods taken from last purchase, $380 each:
      extCOGS=10imes380=3,800ext{COGS} = 10 imes 380 = 3,800
    • Ending Inventory after sales:
    • 2 units from beginning inventory
    • 2 units from previous purchase:
      • Total:
        extTotal=(2imes350)+(2imes380)=1,460ext{Total} = (2 imes 350) + (2 imes 380) = 1,460
  • Summary for August:
    • Total Purchases: 6,0006,000
    • Total COGS: 5,2405,240
    • Ending Inventory: 1,4601,460

Journal Entries Under LIFO

  • June Transactions:
  1. Beginning Inventory: $700
  2. Purchases:
    • August 5: 1,4401,440
    • August 26: 4,5604,560
  3. Sales (last in first out):
    • August 15: 4 units sold =>
      • COGS calculated on recent purchase:
        extCOGS=4imes360=1,440ext{COGS} = 4 imes 360 = 1,440
    • August 31: 10 units sold =>
      • COGS calculated on recent purchase:
        extCOGS=10imes380=3,800ext{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:
      extWeightedAverageCost=extTotalCostofGoodsAvailableforSaleextTotalUnitsAvailableforSaleext{Weighted Average Cost} = \frac{ 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=2,140700 + 1,440 = 2,140
    • Units Available = 6 units
    • Weighted Average Cost:
      extWeightedAverageCost=2,1406=356.67ext{Weighted Average Cost} = \frac{2,140}{6} = 356.67
    • August 15 Sale: 4 units sold
    • COGS:
      4imes356.67=1,4274 imes 356.67 = 1,427
    • Ending Inventory after Sale: 2 units
    • Cost:
      2imes356.67=7132 imes 356.67 = 713
    • August 26 Purchase: 12 units at $380 each
    • New Total Cost:
      713+4,560=5,273713 + 4,560 = 5,273
    • Unit Calculation for Weighted Average Cost:
    • New Weighted Average:
      extWeightedAverageCost=5,27318=376.64ext{Weighted Average Cost} = \frac{5,273}{18} = 376.64
    • August 31 Sale: 10 units sold:
    • COGS:
      10imes376.64=3,76610 imes 376.64 = 3,766
  • Summary for August:
    • Purchases: 6,0006,000
    • COGS: 5,1935,193
    • Total Inventory on Hand: 1,5071,507

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 = 6,7006,700
    • Ending Inventory + COGS should equal the total:
      1,507+5,193=6,7001,507 + 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:
      extCOGS=1,427ext{COGS} = 1,427
    • For August 31 sale:
      extCOGS=3,766ext{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.