Mastering Accounting For Inventory Part V

Mastering Inventory is mastering its accounting. Inventories are assets, and COGS are related expenses. Manufacturing Inventory (different from Merchandising) requires splitting Raw Materials, WIP, and Finished Goods. Perpetual Inventory Systems continually adjusts inventory and COGS balances, while Periodic systems adjust at the end of the period. Formula for COGS = Beginning Inventory + Purchases + Freight – Returns/Discounts – Ending Inventory. Accounting for transactions dealing with Inventory constitutes:

1. Dr. Inventory, Cr. AP (on account purchases), before COGS
2. Dr. Freight, Cr. Cash;
3. Dr. AP, Cr. Sales Discount (using the gross method) and Cash;
4. Dr. AP, Cr. Returns;
5. Dr. AR, Cr. Sales Returns; and dependent if Periodic, at the end of the period you will;
6. Dr. COGS, Ending Inventory, and Returns, while;
7. Cr. Beginning Inventory, Freight, and Purchases.

Specific ID matches unit sold during the period, and is usually sold for unique, expensive products with low volume. Average Cost assumes the mix of all available goods for sales, and effectively takes the weighted average.

FIFO assumes first acquired products are sold first, while LIFO assumes last acquired products are sold first.

On a periodic system, Average Cost will take the Weighted Average of (Beginning Inventory + Purchases) / Units Sold.  In FIFO, it will take the costs of beginning inventory first, and if it sells all Beginning Inventory. It will begin to take the costs of the first round of purchases until the last. LIFO, will take the most recent purchase costs, and then work back to beginning inventory. Things to note, in times of rising costs, FIFO to produce lower COGS and higher ending inventory. In times of falling costs, FIFO will produce higher COGS, and lower ending inventory. In perpetual inventory systems, for Average Cost, you will need to re-weight after every PURCHASE. Then you will need to carry over the weight of your inventory balance after sale.

​This is also inclusive of carrying over your COGS balance, after every re-weighting of your balance. For FIFO and LIFO, just like average cost, it is critical to carry over the COGS balance. And FIFO, after every purchase ensures that the oldest units are calculated first, and for LIFO, the most recent purchased units are calculated first.