Methods of calculating inventory cost

As inventory is usually purchased at different rates (or manufactured at different costs) over an accounting period, there is a need to determine what cost needs to be assigned to inventory. For instance, if a company purchased inventory three times in a year at $50, $60 and $70, what cost must be attributed to inventory at the year end? Inventory cost at the end of an accounting period may be determined in the following ways:

• First In First Out (FIFO)
• Last In First Out (LIFO)
• Average Cost Method (AVCO)
• Actual Unit Cost Method

First In First Out (FIFO)

This method assumes that inventory purchased first is sold first. Therefore, inventory cost under FIFO method will be the cost of latest purchases. Consider the following example:

Example

Bike LTD purchased 10 bikes during January and sold 6 bikes, details of which are as follows:

January 1 Purchased 5 bikes @ $50 each

January 5 Sold 2 bikes

January 10 Sold 1 bike

January 15 Purchased 5 bikes @ 70 each

January 25 Sold 3 bikes

The value of 4 bikes held as inventory at the end of January may be calculated as follows:

The sales made on January 5 and 10 were clearly made from purchases on 1st January. Of the sales made on January 25, it will be assumed that 2 bikes relate to purchases on January 1 whereas the remaining one bike has been issued from the purchases on 15th January. Therefore, the value of inventory under FIFO is as follows:

Date	Purchase			Issues			Inventory
	Units	$/Units	$ Total	Units	$/Units	$ Total	Units	$/Units	$ Total
Jan 1	5	50	250				5	50	250
Jan 5				2	50	100	3	50	150
Jan 10				1	50	50	2	50	100
Jan 15	5	70	350				5	70	350
Jan 15							7		450
Jan 25				2	50	100
				1	70	70	4	70	280

As can be seen from above, the inventory cost under FIFO method relates to the cost of the latest purchases, i.e. $70.

Test Your Understanding

Prev

Next

Accounting for Inventory

LIFO Method