**NOTE: You should complete the Accounting Analysis I: The Role of Accounting as an Information System course or be familiar with the concepts taught there before beginning this course.** This course is the second course in a five-course Financial Reporting Specialization that covers the collection, processing, and communication of accounting information (via financial reports) about economic entities to interested parties (i.e., managers and external stakeholders such as stockholders and creditors). To gain the most relevant knowledge from these courses, learners should have taken a basic accounting course prior to this Specialization (which can be done through Coursera courses, such as any accounting course from the Fundamentals of Accounting Specialization: https://www.coursera.org/specializations/accounting-fundamentals). This Specialization focuses on accounting concepts, principles and theory with an emphasis on problems that arise in applying these concepts for external reporting purposes. Specific emphasis is placed on measurement of assets, liabilities, equities and income, as well as disclosure of additional information that may assist users understand the financial reports. In this course, we will begin our review of key asset categories underlying the Balance Sheet concepts that were introduced in the previous course. We will begin our trek down the Balance Sheet by reviewing cash and receivables, which are normally the two assets listed first. We will continue our trek down the Balance Sheet by looking at inventory and long-Lived Assets, which are normally two of the largest asset values. We will review the measurement and reporting issues involving Inventories and the corresponding cost of goods sold expense in the Income Statement. In the latter half of this course we will conclude our review of key asset categories by looking at both tangible and intangible long-lived assets that are so vital to the production of goods and services. This will entail discussion of both acquisition and disposition of property, plant and equipment as well as cost allocation. Next, we will discuss possible impairment of these assets as well as the proper treatment of expenditures made after acquisition. Lastly, we will review how to identify and account for Investments. The University of Illinois at Urbana-Champaign, consistently ranked as one of the nation's top three accounting programs, now offers a master’s in accounting at a very affordable tuition rate and is completely online. The iMSA is a full Master of Accountancy program and students graduate with an MS that is highly recognized. Try an open course or two, then apply for admission into the credit-bearing version as you may be eligible to take credit-bearing courses during the application process. If you are missing any prerequisites for the full degree, you can complete Coursera courses to demonstrate readiness and strengthen your application for the iMSA. For more information on this exciting iMSA online program, refer to this link: https://www.coursera.org/degrees/imsa
Inventory Costing Methods & Factors Influencing Choice
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Do curso por University of Illinois at Urbana-Champaign
Accounting Analysis I: Measurement and Disclosure of Assets
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University of Illinois at Urbana-Champaign
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Curso 2 de 5 em Specialization Financial Reporting
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Module 2: Inventory - Measurement
We will learn about the types of inventory systems, as well as the costs that should be included in inventory. Next, we will understand the various inventory costing methods, as well as key factors on choice of these methods. Lastly, we will discuss inventory ratio analysis, as well as methods of simplifying LIFO.
Conheça os instrutores
Gregory L. Davis, CPA, CMA, CFM, CCMLecturer of Accountancy
Department of Accountancy, College of Business
In this lesson, we'll discuss the inventory costing methods as well as
the key factors that influence their choice among the methods for our management team.
GAAP basically allows three types of inventory costing
methods: Average cost, FIFO, and LIFO.
FIFO is First In, First Out. LIFO is Last In, First Out.
There's a fourth one that's rarely mentioned it's FISH.
We'll talk about that in a little bit later.
Before we review each method,
let's find the nature of the cost of goods sold or COGS.
Basically it's beginning inventory plus purchases,
equals our goods available for sale (GAFS).
If we take the GAFS minus our ending inventory,
our physical count that we take,
we get our COGS or cost of goods sold.
Another way of doing that is take the goods available for sale,
subtract your COGS to push out your ending inventory, either way works.
The Average Cost Method.
Basically this assumes that your units sold come from mixture of all items.
The average unit cost of all goods available for
sale is applied to both your COGS and your ending inventory.
Based to the weighted average unit cost is equal to
the dollar value of your goods available for sale,
divided by the quantity of the same number of items.
Our second method is FIFO,
First In, First Out.
As the name implies,
it assumes that the units sold are the first or oldest units purchased.
The ending inventory here consists of your more recent items.
So if under inflationary times,
which means that something I buy today is going to cost me more in the future,
the cost of the item increases over time.
FIFO result in a lower COGS,
or cost of goods sold, and does a higher ending inventory.
Also, because the lower cost of goods sold,
FIFO is going to result into the highest net income of all.
Now we have the LIFO method.
This assumes that your units sold are the most recent units purchased.
In this case your ending inventory consists of the oldest items.
Keep in mind under inflationary times,
the cost of an item increases over time.
In this case, LIFO result in your higher cost of goods sold,
and your lower ending inventory.
Thus, LIFO is going to result in a lower net income.
Let's review an inventory costing method example of this key data.
Let's say we have beginning inventory of 4,000 units at $5 of unit.
There were three purchases throughout the year,
one on January 15, March 15, and October 15.
You see the different levels of purchases and you'll see that we bought them at $5,
$5.50, and $6 respectively.
So based on this above data,
are we working under inflationary or deflationary prices and why?
Let me give you a minute to think about that.
Yes, hopefully you got it correct.
With the increasing prices,
this means we're under inflationary environment
because the cost of units increase over time.
Let's continue on with our inventory costing method example.
Let's say now there's three different sales levels
throughout the year on January 10 and mid-April and mid-November.
You'll notice I have the units at 2,000, 1,000,
and 3,000 respectively all in a constant price of $6.50 just for illustration purposes.
So in reality, the price would probably have to increase, right?
Because we've had inflationary or higher costs we've
had to deal with we want to pass those on to our customer where possible.
Does everyone think they understand these costing methods?
You'll see on this slide I've got a lot of question marks right?
We want to try and figure this solution now so I'm going to give you some time to
work through the three methods and see if you can figure out the cost of goods sold,
as well as the ending inventory.
And then I'll go over to the white board to hopefully calculate,
summarize, and more importantly, explain the results.
Okay today we're going to take a look at
the different inventory methods that we've talked about.
The average cost, the FIFO, and the LIFO method.
Keep in mind these are some of the raw assumptions we have given on
the data that it's under the periodic inventory system.
As you remember from the pricing,
that's an inflationary pricing environment.
We also have goods available for sale total of 12,000 units that cost us $65,500.
So if you take that division,
your Average Cost per Unit of items available for sale is $5.46 rounded to two pennies.
So let's take a look at the three methods.
First of all Average Cost, pretty straightforward.
We have an average cost of $5.46.
If you remember we sold 6,000 items,
so the cost of that would come out to be $32,750.
Likewise, there are 6,000 items left in ending
inventory so that also is going to be a cost of $32,750.
If I add those two up,
I get to my total which is based on my goods available for sale is $65,500.
Very straightforward method.
Now let's review the FIFO and LIFO method,
there are much more common methods than the Average Cost.
So under FIFO, we have first in,
first out so we pull those first 4,000 units from the beginning inventory of $5.
We then pull the 1,000 units from the January purchase at $5 And lastly,
1,000 units from the March purchase at $550.
When you add those up that's a total cost to goods sold of $30,500.
That basically means you have 6,000 units left in the inventory at a cost of $35,000.
You'll notice once again if I add those two numbers together,
we come up with the exact same goods available for sale,
dollar amount of $65,500.
Key point, that's a great checkpoint for you under each of the three methods.
It should always equal to the same goods available for sale dollar amount.
And lastly, we have LIFO, very appropriate right?
Last in, first out.
Under this methodology we take the most recent units in the inventory that we purchased.
So the 4,000 at the $6, 24 grand there.
And then the next purchase which is 2,000 at 550.
That total would get you to $35,000 of cost of goods sold.
You'll notice that's highest of all.
Kind of makes sense right?
Last in, first out,
most recent prices which are the higher prices coming through the cost of goods sold,
that's at 35 grand.
That leaves us with an ending inventory of $30,500.
Once again, if I add those two together I come out to that same $65,500.
So just to recap, under the three methods,
LIFO under an inflationary pricing environment
will always give you the highest cost to goods sold,
the lowest ending inventory.
FIFO will be the exact opposite.
It'll give you the lowest cost to goods sold,
the highest ending inventory.
And then the Average Cost will be somewhere in between.
That's the way the three methods works.
Hopefully that makes sense among the different three methods of costing our inventory.
So hopefully, I know it's a very lengthy example but
hope for that explains those key difference between
the three methods of costing over inventory and you can see why we use one or the other.
Next, we will discuss the key factors that influence the choice of these methods.
Managers prefer two things: They want to report higher earnings,
most likely that results in higher bonuses at year end.
So in that case we'd want to use FIFO or first in, first out.
They also want to report lower taxes.
That saves cash as less as actually paid out to the IRS now as opposed to a future year.
That is where LIFO is going to be
our most beneficial method because it will cut down our tax impact.
So why can't we achieve both these managerial goals?
Well, there is a key reason,
it's a gap pronouncement.
It's called the LIFO conformity rule.
If LIFO is used on your tax return then it
must also be used in your financial statements,
which precludes us from achieving both goals from the prior slide.
Please note that the IFRS -- that's
International Financial Reporting Standards -- does not allow the use of LIFO.
Thus, many companies will try and use both methods as follows.
They use LIFO on their financial statements as required by GAAP,
since they use LIFO on their tax returns for IRS purposes.
Then they also might use FIFO for all their internal records for their,
quite honestly, their profit and their different bonus calculations.
This creates something we call "LIFO reserve".
Basically a "LIFO reserve" is an inventory contra-account.
It offsets the inventory.
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