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Unit 11: Inventory Management

inventory cost flows. The valuation inventory cost flows is more relevant, rather than physical Notes
flow of inventory. A number of costing alternatives are used. First In, First Out (FIFO) assigns
the most recent cost to inventory and the oldest costs to cost of goods sold. Last In First Out
(LIFO) assigns the most recent costs to cost of goods sold and oldest costs to inventory. A third
alternative is to assign an average cost to inventory and cost of goods sold. The inventory cost
flow does not have to follow the physical movement of inventory. Inventory valuation using
FIFO, LIFO or average cost should satisfy the matching concept. The management choices in
Accounting for Inventories are given in Figure

11.5.2 Valuation of Periodic Inventories

In periodic inventory systems, used primarily by trading organizations, purchases of inventory
are recorded in a purchases account rather than directly in the inventory account. When merchandise
is sold, the sales revenue is recorded but entry is made in cost of goods sold. Cost of goods sold is
computed at the end of the accounting period, when financial statements are prepared.
In a trading organization, the beginning inventory balance and the purchases account balances
represent the cost of goods available for sale. In order to calculate the cost of goods sold, a
physical count is made of the merchandise remaining on hand. The next step is to value the
inventory in hand by assigning to each unit a cost based on some cost flow assumption such as
FIFO, LIFO or weighted average. The value of ending inventory is deducted from the cost of
goods available for sale to compute cost of goods sold.

Example: In case of B Ltd., the opening balance as on 1st July consist of 18 units costing
10 each. During July, the company purchased 32 additional units as follows:
July 1 Beginning balance 18 units @ 10 180
July 11 Purchases 10 units @ 10.50 105
July 25 Purchases 12 units @ 11 132
July 30 Purchases 10 units @ 12 120

Total 50 units 537
During July, the company sold 30 of the 50 units available for sale leaving an end inventory of
20 units. Sales were as follows:
July 3 Sale 8 units

July 17 Sale 5 units
July 28 Sale 17 units
Total 30 units
In order to prepare financial statements, B Co. Ltd. must assign value to the 20 units, end of the
period inventory and 30 units, which were sold. The value depends on the inventory method
used by the company and on the cost flow assumption adopted. First, let us consider periodic
inventories followed by perpetual inventory systems.

FIFO (First In First Out)
As the name suggest, the materials are issued in the order in which they are received in stores.
Thus, each issue of material recovers the purchase price, which does not reflect the current
market price (if the prices do not remain same). This method is considered suitable in time of
falling prices because the material cost charged to production will be high while the replacement

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