**Fifo/Lifo/Average**** Cost**

**Who cares?**

Well, you
should! It will be on the exam.

Let’s see
what is going on.

First,
recall cost of goods sold (CGS) impacts the income statement as to the amount
of profit generated.

Recall
also that inventory is an essential element of that CGS calculation:

Thus**: cost** **of goods available for sale** (here shown as $12,000) – **ending inventory** = **CGS**

Also recall that the ** cost
of goods available for sale** represents the beginning inventory and all
purchases made during the applicable time period. It is not YET reduced for sales. In other words, it was the universe of all
available items/merchandise that COULD have been sold.

**FIFO:**

Look at your textbook,
page 256, for the basic table shown for FIFO.

Again, recall this chart
is telling you the total “universe” of all items in beginning inventory and/or purchased or on hand during
the year. It is ** not**
telling you when things were sold.
Notice also the prices were different at various times during the year.

Thus, for **ending** inventory (given to you in the
problem/text) of **450** units, we have
to calculate the value.

The book said we had 1000
total units available for sale during the
year. Thus, that means to determine,
under FIFO (first in, first out), what the economic cost of the remaining (** still
unsold**) inventory is.

First in first out means
the **first**
items received are ** deemed** sold first and we continue until we get to that
inventory (physical count) amount (ie., here meaning
the inventory starting with the Jan 1 beginning inventory, Apr 15 inventory
purchase, etc.

Thus, for ending inventory,
we must determine what the **financial** value is for those 450 units. We start
at the last received items, since they are considered **retained**
or still in inventory. We first see 400 units.
We add them to your calculation, and extend their unit cost, or $13, and
get the $5200.

è Now for the part that confused people. We have considered 400 out of **450**
units remaining in inventory. Where do we get the other **50**?

We “take” or calculate
them from the next layer up,
or the Aug 24 batch of 300 units and also continuing the same direction we went
when we started the process (recall we started with the 400 units on Nov 27, or
started at the bottom and we are working up).
Thus 400 + 50 is 450. **Notice that the remainder of the Aug 24 batch is now considered to
have been sold in the amount of 250 (or 300
-50).**

REMEMBER THIS IS NOT
NECESSARILY A TRUE ITEM FOR ITEM ** physical**
treatment of how the items were sold, this is ONLY an
accounting entry.

Thus, to calculate cost of
goods sold (CGS) we simply take the total cost of goods available for sale (the
$12,000) [recall this is the total available inventory that could be sold when
you add in the beginning inventory and ALL purchases during the time period]
and **subtract
**the ending inventory of $5800 and get the CGS of $6200.

** And we can prove this
calculation**. It’s a little work, but to prove this, we
simply add up and extend the items that are considered

100
10 1000

200
11 2200

__250__ 12 __3000__

550 6,200

Recall 550 units were considered sold. THUS, **First**** in, first out, means we sold the oldest first, while the newest received purchases/inventory is
considered to remain in inventory.**

**LIFO **

The same approach is taken
for LIFO. See the same assumptions on Cost of goods available for sale, see page 257.

Here, however, we consider
the oldest items to be sold LAST, while the newest items are considered sold
first. Thus, for ending inventory, we consider the **oldest**
items in our universe of items available for sale to be STILL IN THE INVENTORY
(Dollar value wise).

Thus, for our ** ending inventory** of 450, we go to the

Thus, the end result is
ending inventory, when you “extend” it all out, of $5000. See the text.

The Cost of goods sold is
simply $12,000 less the ending inventory of $5000, or $7000.

You proved your CGS
calculation by calculating the amount sold, by going from the **newest**
back, or 400 @13 + 150 @12= 7000.

**In other words, it is the reverse
of what you did before, because under LIFO, the last (i.e., the newest)
inventory you bought is considered to be sold first, while under FIFO, the oldest
inventory/purchases you bought/had is considered sold first**.

**AVERAGE COST**

The compromise and most
logical at times is the average cost computation.

Here you simply take a
mathematic average of the cost of all the items you have purchased and then
extend it by the ending inventory.

Here, we had 1,000 total
items available which cost a total of $12,000.

12,000/1000= average unit
cost of $12

Ending inventory= 450 * 12= $5400

CGS= 12,000-5,400 or 6,600

Proof: 550 sold items * 12= 6,600.

Now, look over the chart on page 260 and notice the
impact on the gross profit between the three methods and read carefully the
materials in book!