Running head: INVENTORY COSTING METHODS

Inventory Costing Methods

Name
Institution

INVENTORY COSTING METHODS

The utilization of Perpetual Inventory System gives a running balance of actual cost of
goods available for sale as well as the cost of goods sold. It follows that there is no purchases
account maintained as the inventory account is debited with each purchase of goods. All the
expenses incurred to get the goods inventory greatly raise the cost of goods available for sale. In
addition these expenses are also debited to inventory account. Each time the goods are sold, the
associated cost is moved from inventory account to cost of merchandise sold account. This is
achieved by debiting both cost of goods sold and crediting inventory account.
On the other hand, periodic inventory system account is normally not updated for each of
the purchase and sale. It entails debiting all purchases to the purchases account. To get the cost of
merchandise available for sale at the end of the period, the total in purchases account is added to
the beginning balance of the inventory. Consequently the ending inventory is subtracted from the
cost of goods available for sale so as to get the cost of goods sold. This ending inventory is
calculated at the end of the period by making a physical count.
The first-in, first-out (FIFO) inventory costing method is a popular inventory valuation
method that makes an assumption that the merchandise sold by merchandising companies or
goods produced by manufacturing companies occur in the order in which they are purchased (i.e.
the costs to acquire goods or materials are computed against revenues in the order in which they
occur). Under this type of inventory costing method, the ending balance of inventory shows the
most recent costs incurred to purchase goods (merchandise) or materials. The utilization of this
method is thus very common in calculating the cost of goods sold and the ending balance of
inventory for both the perpetual and periodic inventory systems. This implies that the costs are
made in the order they were charged to cost of merchandise sold. In other words, the first costs
incurred become the first costs charged to cost of merchandise sold.

INVENTORY COSTING METHODS

Nevertheless, when a sale is made in a periodic inventory system, the entry to record the
cost of merchandise sold is not made. The ending inventory at the end of accounting period is
computed by a physical count and if the FIFO inventory costing method is used to calculate the
cost of ending inventory, the cost of most recent purchases are used. Therefore, the cost of goods
(merchandise) sold can be obtained via a formula as follows: Cost of merchandise sold =
(Beginning inventory + Purchases) Ending inventory.
For instance, lets consider that prices of a given commodity are increasing. Also, keep in
mind that operating expenses remain unchanged regardless of either system. In this scenario if a
merchandising or manufacturing company were to utilize the FIFO, would result in benefits and
downfalls to a company utilizing it. Take for example, the fact that FIFO results in lowest costs
of goods sold and higher gross profits. Because operating expenses are the same regardless of the
inventory system used, the net income is shown as the higher one of the two systems for FIFO.
This is beneficial as it provokes interests for potential investors in the market. With an expected
higher net income, a company may have more investors and grow substantially faster than a store
operating under LIFO which provides less income. This forms the major benefit to a FIFO
system.
LIFO on the other hand, under these same rising prices conditions, may lead to high cost of
goods sold and the lowest gross profit. But with lower profit means less taxes. As a result, LIFO
helps such a company during a time or rising prices because they save money on taxes which
increases the flow of cash. This forms the main benefit of using this system. The drawback to
this system is that, the company reports show lowered net income (Needles, Powers & Crosson,
2011, pg. 365).

INVENTORY COSTING METHODS

Work cited
Needles, B., Powers, M., & Crosson, S. (2011). Principles of accounting. Mason, Ohio: Cengage
Learning.