Inventory and Cost of Goods Sold: Key Points

Introduction

• Inventory is a key asset for retailers, distributors, and manufacturers.
• Includes goods awaiting sale, raw materials, and work-in-process.
• Recorded on the balance sheet at cost.

Cost of Goods Sold (COGS)

• When sold, inventory cost is removed and reported as COGS on the income statement.
• COGS is usually the largest expense.
• Subtracting COGS from sales gives gross profit.
• Quick sale of inventory is crucial to maintain cash flow.

Cost Flow Methods

• FIFO (First In, First Out): Oldest costs are reported as COGS; recent costs remain in inventory.
• LIFO (Last In, First Out): Most recent costs are reported as COGS; oldest costs remain in inventory.
• Weighted Average: Calculates an average cost per unit for COGS and inventory.

Inventory Systems

• Periodic System: Inventory account updated periodically; end-of-year adjustments determine COGS and ending inventory.
• Perpetual System: Continuously updates inventory; requires periodic physical counts for accuracy.

Estimating Inventory Costs

• Gross Profit Method: Uses historical income data for estimating ending inventory.
• Retail Method: Calculates cost-to-retail ratio to estimate inventory costs from retail data.

Examples

• Corner Bookstore: Demonstrates the application of cost flow methods under periodic and perpetual inventory systems using hypothetical data.
• Periodic FIFO/LIFO/Average: Calculations done at year-end.
• Perpetual FIFO/LIFO/Average: Continuous calculations for each transaction.

Additional Concepts

• Specific Identification: Items are expensed based on their specific cost.
• LIFO Benefits: Can result in tax savings during inflation.
• Inventory Management: Reducing inventory levels via just-in-time delivery can be beneficial.

Financial Ratios

• Important ratios: Inventory Turnover Ratio and Days Sales in Inventory.

Conclusion

• Choosing the right method depends on the company's circumstances and financial strategies.
• Professional advice recommended for tax implications and inventory management strategies.

Further Study

• Suggested quizzes and PRO Plus materials for deeper understanding and certification.