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Accounting for Inventories


24 Minute Accounting

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Unit Video

Unit Summary

The four methods available to value an organization’s closing stock are:
  1. FIFO – First In First Out method
  2. LIFO – the Last in First Out method
  3. Weighted Average (WA)
  4. Specific Identification

Survey Questions

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Hi, in this video you will learn how to account for (value) Inventories, or stock (as most people refer to it).
For some organizations, sale of Inventories represents most, if not all, the revenues generated. We need to remember that :
Opening Stock + Purchases – Closing Stock will give you Cost of Goods Sold (COGS).
Accounting for inventories (COGS) correctly will impact your financial results.
Unless you sell all the inventories that you purchase within an accounting period, you will need to account for the remaining inventories on hand. Depending on how you value your closing inventories, your Gross Margins will be impacted.
There are four (4) methods available to value an organization’s stock. Depending on the type of stock being sold, there will be a more suitable method that you should use.
  1. FIFO – First In First Out is a method whereby it is assumed that you sell your older stock first and the ending stock is your newest purchases. It is very common for businesses to use the FIFO method if they trade in foodstuffs and other goods that have a limited shelf life, because the oldest goods need to be sold before they pass their sell-by date.
  1. LIFO – the Last in First Out method assumes that you sell your newer stock first and your remaining stock is from your opening stock and your earlier purchases. Industries such as mining and lumber, prefer to use LIFO as they stack their heavy inventory in piles, and tend to sell off the newest inventory (at the top of the pile) first.
  2. Weighted Average (WA) – The weighted average method uses the formula: Total cost of items in inventory available for sale divided by total number of units available for sale. Therefore each unit is assigned the same cost. Agriculture, Petroleum and Pharmaceutical companies use the weighted average method, as it is hard for them to determine the cost of their closing stocks, and WA is a much fairer valuation method.
  3.  Specific Identification – this method requires a detailed physical stock count to take place, so that the company knows exactly how many units of each stock keeping unit (SKU’s) bought on specific dates remained at yearend inventory. This is a more time consuming method, however it will generate the most accurate results. This method is more suitable for “Big Ticket” items, or items that have high sales prices.
The CFO and / or the Chief Accountant need to decide on which method of accounting for inventories needs to be followed by their organization. Once this decision has been taken, it should be followed during the accounting period.
If the cost of buying inventory were the same every year, it would make no difference whether a business used LIFO, FIFO or Weighted Average. However, as costs do change, then you will need to use the method that would provide you with a fair evaluation method. You don’t want to be fooled with the value of your inventory, or even your financial results, so use the most appropriate valuation method and stick by it!

The more inventory a company has, the less likely they will have what they need. Taiichi Ohno