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The raw materials, work-in-process goods and completely finished goods that are
considered to be the portion of a business's assets those are ready or will be ready for sale.

Cost of inventory:

÷ Purchase price and other directly related cost incurred in process of buying and
preparing inventories for sale
÷ Manufacturing cost (raw material, direct labour and over head cost)

The accounting choices of Inventory affect the firm¶s income statement, balance sheet and
related ratios. Per haps more important , in contrast to most financial reporting options, the
choice of inventory method has real cash flow effects as it affects income taxes paid by the
firm.

Inventory methods:

÷ ë ë
ë   ë 

regards the first unit that arrived in inventory as the first one
sold.
÷ u ë
u   ë 

 considers the last unit arriving in inventory as the first one
sold
÷ c 

  




COGS = beginning inventory + purchases ± ending inventory 

    


   
 



January 1,000 $10 $10,000
February 1,000 $12 $12,000
March 1,000 $15 $15,000

   
*eginning Inventory = 1,000 units purchased at $8 each (a total of
4,000 units)







 





  !"#$%

 &
 

 ' () ( () *
+

, -./
 $60,000 $60,000 $60,000
*eginning Inventory 8,000 8,000 8,000
Purchases 37,000 37,000 37,000
Ending Inventory (appears on * S)
8,000 15,000 11,250


 01
)2 $37,000 $30,000 $33,750
Expenses 10,000 10,000 10,000
3  .4 ./ .45/6
*Note: All calculations assume that there are 1,000 units left for ending inventory:
(4,000 units - 3,000 units sold = 1,000 units left)

What we are doing here is figuring out the ending inventory, the results of which
depend on the accounting method, in order to find out what COGS is. All we've done
is rearrange the above equation into the following:

*eginning Inventory + Net Purchases - Ending

Inventory = Cost of Goods Sold

' ()7  +

1,000 units X $8 each = $8,000
 ,
Remember that the last units in are sold first; therefore, we leave the
oldest units for ending inventory.

( ()7  +
1,000 units X $15 each = $15,000
 ,
Remember that the first units in (the oldest ones) are sold first;
therefore, we leave the newest units for ending inventory.

*
+7  + [(1,000 x 8) + (1,000 x 10) + (1,000 x

 , 12) + (1,000 x 15)] 4000 units =
$11.25 per unit

1,000 units X $11.25 each = $11,250

Remember that we take a weighted average of all the units in
inventory.
 uIFO: allocates most recent purchase price to COGS. is the most
informative accounting method for income statement purpose. It
provides a better measure of current income and future
profitability.(good for income statement and economic perspective)
FIFO: leaving most recent costs in ending inventory. It pro vides a measure of
inventory that is closer to its current value . (Good for balance sheet)
Weighted-Average: is the worst of three choices. It tends to be closer to FIFO
than uIFO especially with respect to inventory costs on balance sheet.


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A company generally reports lower net income and lower book value, due to the
effects of inflation. This generally results in lower taxation. Due to uIFO's potential to
skew inventory value, UK GAAP and IAS have effectively banned uIFO inventory
accounting. In U.S, IRS regulations require that the same method of inventory
accounting using for tax purpose also be used for financial reporting.
Many companies will also state that they use the "lower of cost or market." This means that if
inventory values were to plummet, their valuations would represent the market value (or
replacement cost) instead of FIFO, uIFO or average cost.uCM can be used with uIFO for
financial statement purpose. However, for tax purpose uIFO cannot be combined with uCM.

Adjustment of inventory balances:

 u

 
  

  
u
   
  
    

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 u


The dhange in the balande during the current year represents the current year¶s inflation in
costs.

To make the conversion possible, U.S. GAAP requires companies that use uIFO to report a uIFO reserve (found
in footnotes). The uIFO reserve is the difference between what their ending inventory would have been if they
used FIFO.

  
' (), FIFO inventory - uIFO inventory
Or:

( ()  , uIFO inventory + uIFO reserve

Recall:

COGS = beginning inventory + purchases ± ending inventory

Or:
COGS = change in inventory levels

So:

)2 ( ()#,)2 ' ()# 8
+ ' ()

Or

)2 ( ()#,)2 ' ()# 8 ' ()
  " ! &' ()

 0+  +" !# 


A longer way to convert uIFO to FIFO is to calculate purchases, convert both

beginning and ending inventory to FIFO levels, and then calculate COGS
using the FIFO inventory levels and purchases.

COGS = beginning inventory + purchases ± ending inventory

Purchases = ending inventory - beginning inventory + COGS (uIFO)

*9 "   $ 
There are two reasons for making this adjustment.
1-estimating the impact of price changes on firm¶s COGS and earnings
2-comparing the firm with other firms in the same industry using uIFO method
(Note that only the adjustment of COGS to uIFO COGS is relevant)

FIFO-TO-uIFO V COGSu= COGSF + (*IF × r)

 r is the specific inflation rate appropriate for the products in which the firm
deals.
WHEIGHTED-AVERAGE-TO- uIFO V COGSu= COGSW + (*IW × r 2)

M

r=

 
this procedure provides a reasonable approximation of r as long as the uIFO
firm has not had a significant reduction of its inventory from year to year.

Financial ratio
      
 
 
 

   
    

 
    

   
  
   

     
  
  

  




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better to use uIFO debt-to-equity ratio because the retained earnings are more representative of the
current economic reality. For the time, interest-earned ratio is more relevant to use uIFO because E*IT
will be lower and more representative of future interest-coverage protection. If the company is currently
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If the price of a company's inputs (such as steel, lumber, etc.) is rising:

( () $
÷ COGS will be understated.
÷ Income will be overstated.
÷ The company will pay more income tax and have a lower cash flow.
÷ Assets on the balance sheet will be more reflective of the actual market value.
÷ Working capital and current ratio will be increased.

' () 
÷ COGS will be more reflective of current market environment.
÷ Income will be lower.
÷ The company will pay less income tax and cash flow would be higher.
÷ Assets would be understated and not reflective of its market value.
÷ Working capital and current ratio will be decreased.

*
+& 
÷ Since it's an average, it would be in between uIFO and FIFO

!" "
  

÷ If this method is used, it is extremely hard to tell, since each product has been accounted for
individually.