Inventory Valuation – FIFO (First In First Out), LIFO (Last In First Out), Average Cost and Specific Identification Method

And after we calculate that we, using this formula can estimate how many items we have sold.  So it is opening plus purchase minus closing inventory and we will calculate how many items we have solved.  This system requires less expenses however it is not so precise so usually quantity sold concludes also stolen and damaged or disappeared the inventory since we are not tracking each transaction and we do not track physically how many items were actually transferred out and sold.


Only we know that from the accounting documents but the accounting documents might not reflect the actual situation.  However businesses still use this system since it requires less expenses and here we will just need to close our control over our movements of inventory from warehouses.  With respect to calculation of cost of sales and closing value of inventory, we can use for evaluation methods.


FIFO average price, exact price and LIFO, let’s talk about each of them in more details so FIFO is first in first out and here for the accounting purposes we assume that we sell items acquire the earliest.  However physically it is not required to do the same so we have pile of goods physically it is not required take out those goods which were acquired the earliest.  Let’s assume that you have fuel so you will not be able physically determine which items or which tons of fuel where acquired at the earliest since fuel usually is mixed in the tank and physically you cannot separate that fuel based on the acquisition date.


However, from the accounting point of view this assumption is made and in the example we can see that if the company had three items of inventory on hand and one item is sold from first in first out method we assume that we sell the item which was acquired at the earliest and we include the cost of that item into cost of goods sold.  So the earliest acquired item was on the July 5 and the cost is $90 so we include that cost into the cost of sales and in the inventory on hand the other two items remain so value of closing inventory to $107 in the items acquired later on are remaining in the closing inventory.


Another method is LIFO or last in last out and here we assume that we sell the item acquired at the latest so for accounting purposes we assume that we include into the cost of that item which was the latest acquired.  Here you can see again the same picture however when we calculate cost of goods sold we take the latest acquired item which was acquired on July 20 and it goes into the cost of goods sold $95 and those items which were acquired at the earliest are included into the value of closing inventory.


These are $210.  Another method which we can use to calculate cost of sales and value of closing inventory average price and here we do not make any assumptions which particular items are sold but we just calculate the average price of one item having all inventory on hand so it is done like this.


If we have a free items we sell and there is no assumption which item is sold.  We adopt total value of all inventory and divided by the quantity so we have 3 items.  We adopt cost of all 3 items and we get $101.7 average price and that average price is included into cost of goods sold.  The value of closing inventory is also estimated based on the average price so we have two items left and the average price multiplied by two and we get $203.4 so this is the value of closing inventory.


And the last method in estimating cost of sales and the value of closing inventory is exact price.  This method is used when we exactly know what item was sold and usually such method is used for high value goods or for those goods which have existing separate qualities.  For example if we sell cars of course we know which car we have sold exactly and we know of the exact acquisition cost of that car.


So here we sell the car which was acquired on July 12 and it has cost to $112 and this amount goes to cost of good sold and we know what exact vehicles are remaining in the closing inventory and we adopt together that cost and we get cost of closing inventory $193.  So that was the last of the four inventory evaluation and methods.

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