Cost Flow Assumptions

hello and welcome to this session in which we would look at Cost flow assumption the first word I want to emphasize on is it's an assumption it's an assumption of how inventory cost flows goes from the balance sheet to the income statement simply put we have the inventory account and we have a cost of goods sold we acquire inventory and once we sell the inventory it would leave inventory and goes to cost of goods sold at get expense now inventory cost flow assumption is the Assumption of how to account for those changes for those transfer from inventory to cost flow the company don't have to choose the same method that it actually matches the actual physical flow therefore what we're going to be learning about is assumption we could assume any method we want to and they're going to have we're going to learn about various assumptions the first assumption is going to be called FIFA or first and first out we assume the inventory that we brought in first are the inventor Authority that we got rid of first first and first out or we could have a life assumption the inventory that we purchased last is the inventory that we are going to be selling first so last then the last inventory that we purchased is the LA is the first inventory that we get rid of in the real world most inventory most inventory is fifo first and first out think of a grocery store in a grocery store they want to sell the apples they want to sell the lettuce they want to sell the pears they want to sell the strawberry the old one first first and first out otherwise they will go bad and for most merchandise you want to get rid of the old inventory first lifo stands for last and first out you are assuming that the inventory that you purchased last are the inventory that you sell first again those are assumptions and we we have a method called the weighted average and we have another method that's not really an assumption it's called the specific identification I will discuss the specific identification in a separate example now also to learn about the cost flow assumption you have to know our how do we track inventory remember we have two methods to track inventory periodic method and the Perpetual method before we proceed any further I have a public announcement about my company forehead lectures.com forehead accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses my CPA material is aligned with your CPA review course such as Becker Roger Wiley gleam miles my accounting courses are aligned with your accounting courses broken down by chapter and topics my resources consist of lectures multiple choice questions true false questions as well as exercises go ahead start your free trial today no obligation no credit card required now if you don't know what the periodic or the Perpetual method I would strongly suggest you take a look at the previous recording because in this session I'm going to be showing you the periodic method as well as the Perpetual method side by side this topic is covered an Intermediate Accounting and heavily on the CPA exam so it's very important that you learn this topic inside out the best way to illustrate this concept is to actually work an example so we're going to be working with Adam inventory information and it's very important whatever it's going to be on this slide is you copy it down because we're going to be using this data to illustrate all three concepts so we're going to be working with a company with a starting beginning inventory of 5000 units and they paid for those five thousand unit five dollars per unit so the total cost is 25 000 this is what we call beginning inventory January 1st then throughout the year the company made various purchases on January 10th they bought 1000 unit at six dollars on April 22nd they purchased 3 000 units at seven dollars on November 15 they purchase an additional 3000 unit at 7.50 and these are the total all in all they started with five thousand unit they purchased seven thousand additional unit they have available unit for sale twelve thousand dollar and the total cost the total cost for beginning inventory plus purchases is seventy four thousand five hundred and we call this seventy four thousand five hundred Goods available for sale and you're gonna see this number the seventy four thousand five hundred and the twelve thousand repeatedly throughout this recording so you need to understand what these numbers are twelve thousand unit is the twelve thousand unit that we have available for the whole year that includes beginning inventory plus oral purchases and seventy four thousand five hundred is our cost of goods sold throughout the year we made three sales we made the sale on January 15th for 3500 unit on April 27th for 1 500 unit in November 20th three thousand unit in other words we sold 8 000 Unit 8 000 of the twelve thousand the question is which eight thousand unit we sold look on January 15th we sold 3500 well which three thousand five hundred did we sell did we sell the 1000 from this batch and two thousand five hundred from this batch or did we sell the whole 3500 from the five thousand or did we sell you know 500 from this you know a thousand from this so on and so forth so the question is which unit did we sell and this is where the cost flow assumption comes into effect comes into play in which four thousand unit do we have left because if we start if we have available of eight I'm sorry if we have 12 000 available we sold eight we must have four thousand available let's take a look at this in terms of unit we started with five purchase seven we have twelve thousand unit available again those twelve thousand unit four thousand remained on hand at the end of the year we still have four thousand unit and we sold eight thousand units so notice that twelve thousand will have to be split eight to four okay ending plus sold will equal to twelve thousand this is in terms of unit now let's take a look in terms of the other amount we had five thousand unit at five dollars the beginning inventory was twenty five thousand eight thousand unit purchases purchased at various prices forty nine thousand five hundred total twelve thousand unit and the total Goods available for sale is seventy four thousand five hundred so together the twenty five plus the forty nine five hundred equal to Goods available for sale the goods available for sale will have to be split between ending inventory and cost of goods sold so again you're gonna see the seventy four thousand five hundred and the twelve thousand unit repeatedly throughout the second recording so to start I'm going to start to show you the various assumptions that we can make the first assumption we can make is use average cost to assign cost of goods sold in ending inventory so our ending inventory and cost of goods sold will be a mix and the mix will be the average cost of the goods available for sale and we're gonna starting with the periodic inventory remember you need to know the difference between periodic and Perpetual the periodic is easy to compute because you only have to do the computation once at the end of the period you compute an average price and you will assign this average price to ending inventory and to cost of goods so let's take a look at the example we started with 5000 unit at five dollars then we purchased forty nine thousand five hundred worth of product which is eight thousand unit so the total was seventy four thousand five hundred this is how much we invested this is how many units we purchased so in the periodic we find the periodic average which is seventy four thousand five hundred divided by twelve thousand unit our average cost is six dollars and twenty Cent now what we do we say we still have four thousand unit at six twenty and eight thousand unit at six twenty together if you add them up they should always add up to seventy four thousand five hundred so notice some of some of the 74 500 is ending inventory and some of it cost of goods sold it's split between the two remember if you give more to ending inventory you're going to take away from cost of goods solder if you get more to cost of goods sold you're going to be taken away from inventory so this is how it works this is for the average cost using the periodic now let's learn about the average cost Perpetual Perpetual is a little bit different you're going to have to compute a moving average a changing average every time you make a purchase so rather than having one average notice here under the periodic it's easy you have to compute one average one average you compute the average is cost of goods available for sale divided by how many units you have available while the moving average you have to add the cost of the previous inventory balance to the cost of the new purchase then divide the total cost by the number of units on hand let's see how the Perpetual inventory works we started with 5000 unit at five five dollars which is total of twenty five thousand then on January the the 10th we made a purchase remember as we just stated every time you make a purchase every time you make a purchase you have to calculate a new average well I have five thousand um I have 25 000 from the original beginning inventory and I invested an additional six thousand the total invested is 31 000 and I have now six thousand unit five thousand from the beginning and one thousand from January the 10th therefore my new average cost should be between five and six and my new average cost is 31 000 divided by six is five dollars and sixteen Cent and it should be closer to five because I have more units purchased at five dollars next January 15 I made the sale I sold 3500 unit which 3500 unit I sold it does not really matter why because I have an average cost of 5.16 rounded so my cost of goods sold for that transaction is eighteen thousand and eighty three dollars now I might have sold it for ten twelve dollars per unit it doesn't really care I'm not really keeping track of my sales I'm keeping track of cost of goods sold okay cost of goods sold well if I had six thousand unit and I sold 3500 I must have left 2 500 unit at a cost average cost of five dollars and sixteen cents rounded this is my average inventory twelve thousand nine sixteen then I purchased three thousand unit at seven dollars remember every time I make a purchase I have to calculate a new average well my inventory the 2500 comes down the twelve thousand nine sixteen plus my 21 000 that I recently invested my total invested is 33 916. I had I purchased three thousand and I had two thousand five hundred so I have a total unit of 5500 I'm ready to compute my average my new average is six dollars and sixteen Cent the average cost per unit then I made another sale on April the 27th I sold 1 500 unit at six dollars and sixteen cents I I really don't care which unit I sold I do have a new average cost which is my cost of goods sold is nine thousand two hundred and fifty for that transaction and if I sold one thousand five hundred and previously had five thousand five hundred unit I will have left four thousand unit at six dollars and sixteen cents and this will be my average inventory then I made a purchase three thousand unit at 750. again every time I make a purchase I uh I I compute a new average and what's the average well I have to do I have to find out how much am I invested I invested twenty four thousand six sixty six from the previous transaction I just purchased 22 500 I have 47 166 invested and I have 7 000 unit on hand four thousand come in from the previous period and three thousand I purchased on November the 15th then I made a sale it doesn't matter first before I make a sale I compute my new average my new average is six dollars and seventy six point seven three rounded to 74 but it's going to be 6.738 this is my the money that's invested this is how many units I have then I made a sale of three thousand unit well I'm gonna be using the new average my sale will have a cost of goods sold of 20 20 215 I rounded a dollar it's supposed to be 2014 but it's there's a lot of rounding going on in this example and if if I had seven thousand minus minus four thousand uh minus if I had seven thousand unit available minus three minus three thousand I should have four thousand unit available which is on year end and I do have four thousand unit available at your end and the cost is is six dollars six point seven three eight and um which is the ending inventory is twenty six thousand nine fifty two so this is the ending inventory this is the ending inventory now I'm gonna compute I'm gonna add up all my costs of goods sold well which is eighteen thousand eighty three dollars ninety two fifty and twenty thousand two fifteen my total my total cost of goods sold is 47 548 if I add to it my ending inventory twenty six thousand nine fifty two that's going to give me that magic number seventy four thousand five hundred remember the seventy four thousand five hundred will have to be split between ending inventory and cost of goods sold now you you you you you most likely you're saying hold on a second isn't that the same numbers as the periodic and the answer is yes look periodic and perpetual uh I'm sorry isn't this the same as the average now let's take a look at the fifo method fifo method stands for first in first out well what does it first and first out that means the assumes the the unit that you purchase first are sold first and the ending inventory consists of the most recently acquired unitary your ending inventory consists with consists with the units that you purchased last now what is the positive and negative or what's the advantages and the disadvantages of the first and first out well guess what your ending inventory your ending inventory is recent so your ending inventory is a relevant number it's a recent number why because your ending inventory reflect the most recently purchased your cost of goods sold is old because you are using old cost well regardless we have to find out how to compute cost of goods sold and ending inventory using the periodic inventory well remember how many units we sold we sold 8 000 units again this is based on the original data well if we sold first and first out well we're going to start selling the 5000 unit from the winning inventory that's not going to satisfy the 8 000. now we're going to assume we purchased 1 000 unit on January 10th that's also going to be added at 6 000 then we put on April 22nd we purchased 3 000 unit on April 22nd well of those three thousand we're gonna sell two thousand so notice five thousand plus one thousand plus two thousand those were first in they are sold first those the 8 000 units that are sold then what we have left is one thousand unit from April the 22nd and from November the 15th we had three thousand units so notice those are all our unit the twelve thousand the first eight are sold so the first eight are sold the first eight are sold so notice now we could compute cost of goods sold five thousand unit at five dollars one thousand needed at six two thousand eight seven so we sold eight thousand unit and the cost of goods sold is forty five thousand now this is what's left in ending inventory well what's left is one thousand unit at seven and three thousand unit at 750 total unit four thousand and ending inventory is twenty nine thousand five hundred so again back to the same concept four thousand plus eight thousand equal to twelve thousand those twelve thousand unit are split between cost of goods sold and ending inventory now we are assigning forty five thousand dollar to cost of goods sold in twenty nine thousand five hundred to ending inventory let's add twenty five thousand plus twenty nine thousand five hundred plus forty five thousand that's going to give us the magic number seventy four thousand five hundred so this is how we account for fifo periodically simply put it's it's easy we just wait till the end of the year and say we sold eight thousand unit and we'll start to remove the eight thousand unit from the beginning now let's take a look at fifo Perpetual inventory system using the same figures starting with beginning inventory we have five thousand unit at five dollars the total cost is twenty five thousand our ending balance five thousand unit at five dollars total cost of inventory twenty five thousand on January 10th we made a purchase we purchased one thousand unit at six dollars now for the Perpetual inventory we have to be careful we have to keep track of our inventory and chronological order we're gonna bring down the five thousand unit at five dollars and also we're gonna bring down or add the 1000 unit at six dollars notice the five thousand are listed first to determine those were the inventory that we purchased first now the total inventory is thirty one thousand on January the 15th we sold 3500 units which 3500 we sold well we are using fifo fifo stand for first and first out therefore the first units the five thousand were gonna sell three thousand five hundred of those and what's left is one thousand five hundred of the five dollars now obviously the batch that we purchased at six dollars we did not touch we're gonna bring down again keeping everything at chronological order and basically now we have one thousand five hundred units at five dollars and six thousand uh one thousand unit at six total of Thirteen thousand five hundred on April 22nd we made another purchase well we purchased three thousand unit at seven now we're gonna have three layers of inventory we're gonna have we're gonna bring down the fifteen hundred we're gonna bring down the thousand and we're gonna add to that layer the three thousand therefore we have three layers and total of thirty four thousand five hundred notice we are keeping those layers separately the five dollars the six dollars and this is only seven dollars not seven thousand dollars and this is the first second third if you want to chronologically look at them by April 27th we sold one thousand five hundred units well which method are we using fifo if we sold one thousand five hundred we're gonna take this 1 500 out what's left is the one thousand and the three thousand that's all what we have left and the total inventory is twenty seven thousand November the 15th we purchased an additional three thousand at 750 costing us twenty two thousand five hundred well here's what's gonna happen we're gonna bring down the Thousand at six the three thousand at seven and we're gonna add the three thousand at 750. total inventory ending inventory is forty five eight forty eight thousand at this point November 20th we sold three thousand unit which three thousand unit we sold first and first out the first one is gone and we sold 2 percent of this 3000 if we sold two thousand we still have a thousand at seven now we bring down the Thousand at seven not seven thousand and the three thousand at seven fifty well our ending inventory now is twenty nine thousand five hundred well let's add up all of cost of goods sold forty five thousand well if we take forty five thousand plus twenty nine twenty nine thousand five hundred equal to that magic number seventy four thousand five hundred you might be saying hold on a second when I did fifo perpetual and fifo in fifo periodic I have the same figures and that's correct only fifo perpetual and fifo periodic will give you the same number so notice cost of goods sold is 45 000 under perpetual and ending inventory is 29 500. if we look at fifo per fifo periodic let's take a look at fifo periodic let's take a look at fifo periodic and we're gonna see the same figures just you need to know this so if you are giving fifo periodic and fifo Perpetual remember that it's easier to compute it through periodic and it's going to give you the same figure so just FYI just make sure you're aware of this so notice ending inventory is 29 500 cost of goods sold is forty five thousand same as Perpetual so fifo it's the same not lifo if I thought it's always the same so sometimes it's a shortcut sometimes if you are giving the problem it doesn't matter whether you is periodic or Perpetual you get at the same cost of goods sold the same ending inventory now let's take a look at lifo lifo stand for last and first out this method assumes the last unit acquired are sold first basically the opposite of fifo so the last unit that we purchased are the first unit that we sell again this is assumes it's an assumption so the ending inventory consists of the first acquired which are old units so what is the advantage and the disadvantage of lifo well last unit reflect the latest cost so the latest cost is being matched with the latest sales Therefore your gross profit is accurate why because your cost of goods sold remember gross profit sales Minus cost of goods sold gives you gross profit the cost of goods sold reflect new prices your ending inventory is old so your ending inventory consists of old units that have old prices and those prices could be pretty old and you're going to see later fifo is going to give us some issues we're going to have to deal with later so let's illustrate this method using the same data that we used for the other two methods remember we sold 8000 units well which eight thousand unit we sold we're going to start from last so we're going to assume and that the periodic method we sold the three thousand that we purchased in November the three thousand that we saw that we purchased in April 1 000 that we purchased on January 1st and one thousand that was from the beginning inventory and all of those add up to eight thousand and what's left in our inventory is the four thousand unit that we that were in the beginning inventory at five dollars and again everything at up to twelve thousand units simply put ending inventory consists of old units the old old units of four thousand unit and cost of goods sold consists of the 8 000 unit that I spoke about earlier that we purchased the that we sold the 3750 the 3007 the 1006 and the one thousand at five again total of eight thousand plus four thousand equal to twelve thousand and cost and cost of goods sold is 54 500 again if you take twenty thousand ending inventory plus fifty four thousand five hundred it's going to give us back that magic number seventy four thousand five hundred split between ending inventory and cost of goods sold this is the periodic lifo so you do this at the end Perpetual life oh it's different Perpetual lifo keeps your inventory up to date we're starting with five thousand unit at five dollars then we purchased one thousand unit at six again the key is to keep everything in chronological order just like fifo we have five thousand unit at five one thousand needed at six we sold three thousand five hundred unit on January 15th which three thousand five hundred we're gonna start from last we're gonna get rid of this one thousand and we're gonna be completing the order from the other five thousand which is two thousand five hundred well if we use two thousand five hundred of the five thousand we must still have 2500 of the five thousand and this is from beginning inventory on April the 22nd we purchased 3 000 unit at seven now we add them two thousand unit at five three thousand unit at seven this is our total inventory then we sold one thousand five hundred units which 1 500 unit we sold we sold this from the bottom the three thousand at seven dollars now we sold them for something else maybe we sold them for fifteen dollars sixteen dollars but this is keeping track of cost of goods sold well what do we have left we still have the two thousand five hundred at five dollars and now we still have one thousand five hundred at seven then we purchased 3 000 unit at 750. now we have three batches of inventory the two that we brought in from the prior period from the prior month and the three thousand new unit we have three batches then we sold three thousand unit on November 20th that's easy we sold those three thousand unit plus 10. if we sold that batch what's left is the 2500 and 1500 which is equal to four thousand notice four thousand unit the cost of them the cost for them is twenty three thousand now let's add up cost of goods sold eighteen thousand five hundred ten thousand five hundred twenty two thousand five hundred equal to fifty one thousand five hundred plus twenty three thousand again it's going to give us that magic number seventy four thousand five hundred that's split between ending inventory and cost of goods sold so each method gave us a different figure for example the average method gave us a cost of goods sold of forty two thousand five forty eight ending inventory 26 945 and this is the cost of goods sold for five four forty five thousand the cost of goods sold for lifo ending inventory is different for each method however The Total Money add up cost of goods sold and ending inventory for all three methods it equals to seventy four thousand five hundred again seventy four thousand five hundred is a split between those three figures on the CPA exam in my exam you have to be comfortable in understanding what what what difference does it make if prices are rising or prices are declining so I'm going to explain to you explain to you what happened here what happened here as we were buying inventory the cost of the inventory was increasing the cost is rising so what happened if the cost is rising this is what's happening what's happening is you are matching risk sales with recent cost the recent cost is high well if you are matching sale with recent costs if you're using lifo cost of goods sold will be high so notice if if cost is rise and cost of sales will be high as a result your net income will be low as a result your taxes will be low okay if the opposite is true of course if costs are declining and you are using glypho if you are using glypho well guess what's going to happen your cost of goods sold will be higher your net Prof sorry your cost of goods sold will be lower because recent costs are lower your net income will be higher and your taxes will be higher okay and the opposite is for fifo the uh whatever I said the opposite is for fifo because notice here the costs were Rising fifo gave you a low cost of goods sold so lifo so fifo sorry not lifo fifo of course is rising let's now apply the fifo the cost is rising of cost is rising fifo is going to give you low cost of goods sold why because you are using old cost if you have low cost of goods sold then what you do your net income is higher then your taxes are higher you have to pay more taxes okay prices are declining are declining fifo is going to give you a higher cost of goods sold then you're going to have if a higher cost of goods so you can have lower income and your taxes will be lower now generally speaking costs don't costs don't go down costs usually rise so once you understand what happened when cost rise when cost rise and you're using lifo cost of goods sold is lower your net income is lower and your taxes are lower okay now if you understand this then you'd understand the others the average will give you some place in between fifo and lifo the average numbers now because of that the IRS is aware of this the IRS the government is aware that if you want to use lifo which is lifo is not allowed for international financial reporting purposes if you're using lifo they know if you would use lifo what you would do is you would reduce your income and you would reduce your taxes so there's they have a lifo Conformity Rule and basically what it says if you use lifo for tax purposes if you're using glypho for IRS for tax purposes then you have to use lifo for external financial reporting so simply put you cannot have two sets of books you cannot say for tax I'm gonna use lifo and for Gap I would use fifo you can do that if you use lifo4tax you have to use lifo4 Gap now if you use for tax you'd use fifo you could use anything for Gap if for tax you would use the average you could use anything for Gap the Conformity is for lifo if you use lifo4 gap for tax you have to lose you have to use it for Gap because lifo save you taxes you cannot save taxes then use fifo and show higher income because fifos has a lower cost of goods sold well lifa has many issues we have to deal with and we're going to be dealing with in the next few sessions we're going to have to look apply for Reserve we can have to look at life for liquidation and we're going to have to look at dollar value lifo also in this session I did not cover the specific identification method I will cover it in a separate recording because those are assumptions

hello and welcome to this session in which we would look at Cost flow assumption the first word I want to emphasize on is it&#39;s an assumption it&#39;s an assumption of how inventory cost flows goes from the balance sheet to the income statement simply put we have the inventory account and we have a cost of goods sold we acquire inventory and once we sell the inventory it would leave inventory and goes to cost of goods sold at get expense now inventory cost flow assumption is the Assumption of how to account for those changes for those transfer from inventory to cost flow the company don&#39;t have to choose the same method that it actually matches the actual physical flow therefore what we&#39;re going to be learning about is assumption we could assume any method we want to and they&#39;re going to have we&#39;re going to learn about various assumptions the first assumption is going to be called FIFA or first and first out we assume the inventory that we brought in first are the inventor Authority that we got rid of first first and first out or we could have a life assumption the inventory that we purchased last is the inventory that we are going to be selling first so last then the last inventory that we purchased is the LA is the first inventory that we get rid of in the real world most inventory most inventory is fifo first and first out think of a grocery store in a grocery store they want to sell the apples they want to sell the lettuce they want to sell the pears they want to sell the strawberry the old one first first and first out otherwise they will go bad and for most merchandise you want to get rid of the old inventory first lifo stands for last and first out you are assuming that the inventory that you purchased last are the inventory that you sell first again those are assumptions and we we have a method called the weighted average and we have another method that&#39;s not really an assumption it&#39;s called the specific identification I will discuss the specific identification in a separate example now also to learn about the cost flow assumption you have to know our how do we track inventory remember we have two methods to track inventory periodic method and the Perpetual method before we proceed any further I have a public announcement about my company forehead lectures.com forehead accounting lectures is a supplemental educational tool that&#39;s going to help you with your CPA exam preparation as well as your accounting courses my CPA material is aligned with your CPA review course such as Becker Roger Wiley gleam miles my accounting courses are aligned with your accounting courses broken down by chapter and topics my resources consist of lectures multiple choice questions true false questions as well as exercises go ahead start your free trial today no obligation no credit card required now if you don&#39;t know what the periodic or the Perpetual method I would strongly suggest you take a look at the previous recording because in this session I&#39;m going to be showing you the periodic method as well as the Perpetual method side by side this topic is covered an Intermediate Accounting and heavily on the CPA exam so it&#39;s very important that you learn this topic inside out the best way to illustrate this concept is to actually work an example so we&#39;re going to be working with Adam inventory information and it&#39;s very important whatever it&#39;s going to be on this slide is you copy it down because we&#39;re going to be using this data to illustrate all three concepts so we&#39;re going to be working with a company with a starting beginning inventory of 5000 units and they paid for those five thousand unit five dollars per unit so the total cost is 25 000 this is what we call beginning inventory January 1st then throughout the year the company made various purchases on January 10th they bought 1000 unit at six dollars on April 22nd they purchased 3 000 units at seven dollars on November 15 they purchase an additional 3000 unit at 7.50 and these are the total all in all they started with five thousand unit they purchased seven thousand additional unit they have available unit for sale twelve thousand dollar and the total cost the total cost for beginning inventory plus purchases is seventy four thousand five hundred and we call this seventy four thousand five hundred Goods available for sale and you&#39;re gonna see this number the seventy four thousand five hundred and the twelve thousand repeatedly throughout this recording so you need to understand what these numbers are twelve thousand unit is the twelve thousand unit that we have available for the whole year that includes beginning inventory plus oral purchases and seventy four thousand five hundred is our cost of goods sold throughout the year we made three sales we made the sale on January 15th for 3500 unit on April 27th for 1 500 unit in November 20th three thousand unit in other words we sold 8 000 Unit 8 000 of the twelve thousand the question is which eight thousand unit we sold look on January 15th we sold 3500 well which three thousand five hundred did we sell did we sell the 1000 from this batch and two thousand five hundred from this batch or did we sell the whole 3500 from the five thousand or did we sell you know 500 from this you know a thousand from this so on and so forth so the question is which unit did we sell and this is where the cost flow assumption comes into effect comes into play in which four thousand unit do we have left because if we start if we have available of eight I&#39;m sorry if we have 12 000 available we sold eight we must have four thousand available let&#39;s take a look at this in terms of unit we started with five purchase seven we have twelve thousand unit available again those twelve thousand unit four thousand remained on hand at the end of the year we still have four thousand unit and we sold eight thousand units so notice that twelve thousand will have to be split eight to four okay ending plus sold will equal to twelve thousand this is in terms of unit now let&#39;s take a look in terms of the other amount we had five thousand unit at five dollars the beginning inventory was twenty five thousand eight thousand unit purchases purchased at various prices forty nine thousand five hundred total twelve thousand unit and the total Goods available for sale is seventy four thousand five hundred so together the twenty five plus the forty nine five hundred equal to Goods available for sale the goods available for sale will have to be split between ending inventory and cost of goods sold so again you&#39;re gonna see the seventy four thousand five hundred and the twelve thousand unit repeatedly throughout the second recording so to start I&#39;m going to start to show you the various assumptions that we can make the first assumption we can make is use average cost to assign cost of goods sold in ending inventory so our ending inventory and cost of goods sold will be a mix and the mix will be the average cost of the goods available for sale and we&#39;re gonna starting with the periodic inventory remember you need to know the difference between periodic and Perpetual the periodic is easy to compute because you only have to do the computation once at the end of the period you compute an average price and you will assign this average price to ending inventory and to cost of goods so let&#39;s take a look at the example we started with 5000 unit at five dollars then we purchased forty nine thousand five hundred worth of product which is eight thousand unit so the total was seventy four thousand five hundred this is how much we invested this is how many units we purchased so in the periodic we find the periodic average which is seventy four thousand five hundred divided by twelve thousand unit our average cost is six dollars and twenty Cent now what we do we say we still have four thousand unit at six twenty and eight thousand unit at six twenty together if you add them up they should always add up to seventy four thousand five hundred so notice some of some of the 74 500 is ending inventory and some of it cost of goods sold it&#39;s split between the two remember if you give more to ending inventory you&#39;re going to take away from cost of goods solder if you get more to cost of goods sold you&#39;re going to be taken away from inventory so this is how it works this is for the average cost using the periodic now let&#39;s learn about the average cost Perpetual Perpetual is a little bit different you&#39;re going to have to compute a moving average a changing average every time you make a purchase so rather than having one average notice here under the periodic it&#39;s easy you have to compute one average one average you compute the average is cost of goods available for sale divided by how many units you have available while the moving average you have to add the cost of the previous inventory balance to the cost of the new purchase then divide the total cost by the number of units on hand let&#39;s see how the Perpetual inventory works we started with 5000 unit at five five dollars which is total of twenty five thousand then on January the the 10th we made a purchase remember as we just stated every time you make a purchase every time you make a purchase you have to calculate a new average well I have five thousand um I have 25 000 from the original beginning inventory and I invested an additional six thousand the total invested is 31 000 and I have now six thousand unit five thousand from the beginning and one thousand from January the 10th therefore my new average cost should be between five and six and my new average cost is 31 000 divided by six is five dollars and sixteen Cent and it should be closer to five because I have more units purchased at five dollars next January 15 I made the sale I sold 3500 unit which 3500 unit I sold it does not really matter why because I have an average cost of 5.16 rounded so my cost of goods sold for that transaction is eighteen thousand and eighty three dollars now I might have sold it for ten twelve dollars per unit it doesn&#39;t really care I&#39;m not really keeping track of my sales I&#39;m keeping track of cost of goods sold okay cost of goods sold well if I had six thousand unit and I sold 3500 I must have left 2 500 unit at a cost average cost of five dollars and sixteen cents rounded this is my average inventory twelve thousand nine sixteen then I purchased three thousand unit at seven dollars remember every time I make a purchase I have to calculate a new average well my inventory the 2500 comes down the twelve thousand nine sixteen plus my 21 000 that I recently invested my total invested is 33 916. I had I purchased three thousand and I had two thousand five hundred so I have a total unit of 5500 I&#39;m ready to compute my average my new average is six dollars and sixteen Cent the average cost per unit then I made another sale on April the 27th I sold 1 500 unit at six dollars and sixteen cents I I really don&#39;t care which unit I sold I do have a new average cost which is my cost of goods sold is nine thousand two hundred and fifty for that transaction and if I sold one thousand five hundred and previously had five thousand five hundred unit I will have left four thousand unit at six dollars and sixteen cents and this will be my average inventory then I made a purchase three thousand unit at 750. again every time I make a purchase I uh I I compute a new average and what&#39;s the average well I have to do I have to find out how much am I invested I invested twenty four thousand six sixty six from the previous transaction I just purchased 22 500 I have 47 166 invested and I have 7 000 unit on hand four thousand come in from the previous period and three thousand I purchased on November the 15th then I made a sale it doesn&#39;t matter first before I make a sale I compute my new average my new average is six dollars and seventy six point seven three rounded to 74 but it&#39;s going to be 6.738 this is my the money that&#39;s invested this is how many units I have then I made a sale of three thousand unit well I&#39;m gonna be using the new average my sale will have a cost of goods sold of 20 20 215 I rounded a dollar it&#39;s supposed to be 2014 but it&#39;s there&#39;s a lot of rounding going on in this example and if if I had seven thousand minus minus four thousand uh minus if I had seven thousand unit available minus three minus three thousand I should have four thousand unit available which is on year end and I do have four thousand unit available at your end and the cost is is six dollars six point seven three eight and um which is the ending inventory is twenty six thousand nine fifty two so this is the ending inventory this is the ending inventory now I&#39;m gonna compute I&#39;m gonna add up all my costs of goods sold well which is eighteen thousand eighty three dollars ninety two fifty and twenty thousand two fifteen my total my total cost of goods sold is 47 548 if I add to it my ending inventory twenty six thousand nine fifty two that&#39;s going to give me that magic number seventy four thousand five hundred remember the seventy four thousand five hundred will have to be split between ending inventory and cost of goods sold now you you you you you most likely you&#39;re saying hold on a second isn&#39;t that the same numbers as the periodic and the answer is yes look periodic and perpetual uh I&#39;m sorry isn&#39;t this the same as the average now let&#39;s take a look at the fifo method fifo method stands for first in first out well what does it first and first out that means the assumes the the unit that you purchase first are sold first and the ending inventory consists of the most recently acquired unitary your ending inventory consists with consists with the units that you purchased last now what is the positive and negative or what&#39;s the advantages and the disadvantages of the first and first out well guess what your ending inventory your ending inventory is recent so your ending inventory is a relevant number it&#39;s a recent number why because your ending inventory reflect the most recently purchased your cost of goods sold is old because you are using old cost well regardless we have to find out how to compute cost of goods sold and ending inventory using the periodic inventory well remember how many units we sold we sold 8 000 units again this is based on the original data well if we sold first and first out well we&#39;re going to start selling the 5000 unit from the winning inventory that&#39;s not going to satisfy the 8 000. now we&#39;re going to assume we purchased 1 000 unit on January 10th that&#39;s also going to be added at 6 000 then we put on April 22nd we purchased 3 000 unit on April 22nd well of those three thousand we&#39;re gonna sell two thousand so notice five thousand plus one thousand plus two thousand those were first in they are sold first those the 8 000 units that are sold then what we have left is one thousand unit from April the 22nd and from November the 15th we had three thousand units so notice those are all our unit the twelve thousand the first eight are sold so the first eight are sold the first eight are sold so notice now we could compute cost of goods sold five thousand unit at five dollars one thousand needed at six two thousand eight seven so we sold eight thousand unit and the cost of goods sold is forty five thousand now this is what&#39;s left in ending inventory well what&#39;s left is one thousand unit at seven and three thousand unit at 750 total unit four thousand and ending inventory is twenty nine thousand five hundred so again back to the same concept four thousand plus eight thousand equal to twelve thousand those twelve thousand unit are split between cost of goods sold and ending inventory now we are assigning forty five thousand dollar to cost of goods sold in twenty nine thousand five hundred to ending inventory let&#39;s add twenty five thousand plus twenty nine thousand five hundred plus forty five thousand that&#39;s going to give us the magic number seventy four thousand five hundred so this is how we account for fifo periodically simply put it&#39;s it&#39;s easy we just wait till the end of the year and say we sold eight thousand unit and we&#39;ll start to remove the eight thousand unit from the beginning now let&#39;s take a look at fifo Perpetual inventory system using the same figures starting with beginning inventory we have five thousand unit at five dollars the total cost is twenty five thousand our ending balance five thousand unit at five dollars total cost of inventory twenty five thousand on January 10th we made a purchase we purchased one thousand unit at six dollars now for the Perpetual inventory we have to be careful we have to keep track of our inventory and chronological order we&#39;re gonna bring down the five thousand unit at five dollars and also we&#39;re gonna bring down or add the 1000 unit at six dollars notice the five thousand are listed first to determine those were the inventory that we purchased first now the total inventory is thirty one thousand on January the 15th we sold 3500 units which 3500 we sold well we are using fifo fifo stand for first and first out therefore the first units the five thousand were gonna sell three thousand five hundred of those and what&#39;s left is one thousand five hundred of the five dollars now obviously the batch that we purchased at six dollars we did not touch we&#39;re gonna bring down again keeping everything at chronological order and basically now we have one thousand five hundred units at five dollars and six thousand uh one thousand unit at six total of Thirteen thousand five hundred on April 22nd we made another purchase well we purchased three thousand unit at seven now we&#39;re gonna have three layers of inventory we&#39;re gonna have we&#39;re gonna bring down the fifteen hundred we&#39;re gonna bring down the thousand and we&#39;re gonna add to that layer the three thousand therefore we have three layers and total of thirty four thousand five hundred notice we are keeping those layers separately the five dollars the six dollars and this is only seven dollars not seven thousand dollars and this is the first second third if you want to chronologically look at them by April 27th we sold one thousand five hundred units well which method are we using fifo if we sold one thousand five hundred we&#39;re gonna take this 1 500 out what&#39;s left is the one thousand and the three thousand that&#39;s all what we have left and the total inventory is twenty seven thousand November the 15th we purchased an additional three thousand at 750 costing us twenty two thousand five hundred well here&#39;s what&#39;s gonna happen we&#39;re gonna bring down the Thousand at six the three thousand at seven and we&#39;re gonna add the three thousand at 750. total inventory ending inventory is forty five eight forty eight thousand at this point November 20th we sold three thousand unit which three thousand unit we sold first and first out the first one is gone and we sold 2 percent of this 3000 if we sold two thousand we still have a thousand at seven now we bring down the Thousand at seven not seven thousand and the three thousand at seven fifty well our ending inventory now is twenty nine thousand five hundred well let&#39;s add up all of cost of goods sold forty five thousand well if we take forty five thousand plus twenty nine twenty nine thousand five hundred equal to that magic number seventy four thousand five hundred you might be saying hold on a second when I did fifo perpetual and fifo in fifo periodic I have the same figures and that&#39;s correct only fifo perpetual and fifo periodic will give you the same number so notice cost of goods sold is 45 000 under perpetual and ending inventory is 29 500. if we look at fifo per fifo periodic let&#39;s take a look at fifo periodic let&#39;s take a look at fifo periodic and we&#39;re gonna see the same figures just you need to know this so if you are giving fifo periodic and fifo Perpetual remember that it&#39;s easier to compute it through periodic and it&#39;s going to give you the same figure so just FYI just make sure you&#39;re aware of this so notice ending inventory is 29 500 cost of goods sold is forty five thousand same as Perpetual so fifo it&#39;s the same not lifo if I thought it&#39;s always the same so sometimes it&#39;s a shortcut sometimes if you are giving the problem it doesn&#39;t matter whether you is periodic or Perpetual you get at the same cost of goods sold the same ending inventory now let&#39;s take a look at lifo lifo stand for last and first out this method assumes the last unit acquired are sold first basically the opposite of fifo so the last unit that we purchased are the first unit that we sell again this is assumes it&#39;s an assumption so the ending inventory consists of the first acquired which are old units so what is the advantage and the disadvantage of lifo well last unit reflect the latest cost so the latest cost is being matched with the latest sales Therefore your gross profit is accurate why because your cost of goods sold remember gross profit sales Minus cost of goods sold gives you gross profit the cost of goods sold reflect new prices your ending inventory is old so your ending inventory consists of old units that have old prices and those prices could be pretty old and you&#39;re going to see later fifo is going to give us some issues we&#39;re going to have to deal with later so let&#39;s illustrate this method using the same data that we used for the other two methods remember we sold 8000 units well which eight thousand unit we sold we&#39;re going to start from last so we&#39;re going to assume and that the periodic method we sold the three thousand that we purchased in November the three thousand that we saw that we purchased in April 1 000 that we purchased on January 1st and one thousand that was from the beginning inventory and all of those add up to eight thousand and what&#39;s left in our inventory is the four thousand unit that we that were in the beginning inventory at five dollars and again everything at up to twelve thousand units simply put ending inventory consists of old units the old old units of four thousand unit and cost of goods sold consists of the 8 000 unit that I spoke about earlier that we purchased the that we sold the 3750 the 3007 the 1006 and the one thousand at five again total of eight thousand plus four thousand equal to twelve thousand and cost and cost of goods sold is 54 500 again if you take twenty thousand ending inventory plus fifty four thousand five hundred it&#39;s going to give us back that magic number seventy four thousand five hundred split between ending inventory and cost of goods sold this is the periodic lifo so you do this at the end Perpetual life oh it&#39;s different Perpetual lifo keeps your inventory up to date we&#39;re starting with five thousand unit at five dollars then we purchased one thousand unit at six again the key is to keep everything in chronological order just like fifo we have five thousand unit at five one thousand needed at six we sold three thousand five hundred unit on January 15th which three thousand five hundred we&#39;re gonna start from last we&#39;re gonna get rid of this one thousand and we&#39;re gonna be completing the order from the other five thousand which is two thousand five hundred well if we use two thousand five hundred of the five thousand we must still have 2500 of the five thousand and this is from beginning inventory on April the 22nd we purchased 3 000 unit at seven now we add them two thousand unit at five three thousand unit at seven this is our total inventory then we sold one thousand five hundred units which 1 500 unit we sold we sold this from the bottom the three thousand at seven dollars now we sold them for something else maybe we sold them for fifteen dollars sixteen dollars but this is keeping track of cost of goods sold well what do we have left we still have the two thousand five hundred at five dollars and now we still have one thousand five hundred at seven then we purchased 3 000 unit at 750. now we have three batches of inventory the two that we brought in from the prior period from the prior month and the three thousand new unit we have three batches then we sold three thousand unit on November 20th that&#39;s easy we sold those three thousand unit plus 10. if we sold that batch what&#39;s left is the 2500 and 1500 which is equal to four thousand notice four thousand unit the cost of them the cost for them is twenty three thousand now let&#39;s add up cost of goods sold eighteen thousand five hundred ten thousand five hundred twenty two thousand five hundred equal to fifty one thousand five hundred plus twenty three thousand again it&#39;s going to give us that magic number seventy four thousand five hundred that&#39;s split between ending inventory and cost of goods sold so each method gave us a different figure for example the average method gave us a cost of goods sold of forty two thousand five forty eight ending inventory 26 945 and this is the cost of goods sold for five four forty five thousand the cost of goods sold for lifo ending inventory is different for each method however The Total Money add up cost of goods sold and ending inventory for all three methods it equals to seventy four thousand five hundred again seventy four thousand five hundred is a split between those three figures on the CPA exam in my exam you have to be comfortable in understanding what what what difference does it make if prices are rising or prices are declining so I&#39;m going to explain to you explain to you what happened here what happened here as we were buying inventory the cost of the inventory was increasing the cost is rising so what happened if the cost is rising this is what&#39;s happening what&#39;s happening is you are matching risk sales with recent cost the recent cost is high well if you are matching sale with recent costs if you&#39;re using lifo cost of goods sold will be high so notice if if cost is rise and cost of sales will be high as a result your net income will be low as a result your taxes will be low okay if the opposite is true of course if costs are declining and you are using glypho if you are using glypho well guess what&#39;s going to happen your cost of goods sold will be higher your net Prof sorry your cost of goods sold will be lower because recent costs are lower your net income will be higher and your taxes will be higher okay and the opposite is for fifo the uh whatever I said the opposite is for fifo because notice here the costs were Rising fifo gave you a low cost of goods sold so lifo so fifo sorry not lifo fifo of course is rising let&#39;s now apply the fifo the cost is rising of cost is rising fifo is going to give you low cost of goods sold why because you are using old cost if you have low cost of goods sold then what you do your net income is higher then your taxes are higher you have to pay more taxes okay prices are declining are declining fifo is going to give you a higher cost of goods sold then you&#39;re going to have if a higher cost of goods so you can have lower income and your taxes will be lower now generally speaking costs don&#39;t costs don&#39;t go down costs usually rise so once you understand what happened when cost rise when cost rise and you&#39;re using lifo cost of goods sold is lower your net income is lower and your taxes are lower okay now if you understand this then you&#39;d understand the others the average will give you some place in between fifo and lifo the average numbers now because of that the IRS is aware of this the IRS the government is aware that if you want to use lifo which is lifo is not allowed for international financial reporting purposes if you&#39;re using lifo they know if you would use lifo what you would do is you would reduce your income and you would reduce your taxes so there&#39;s they have a lifo Conformity Rule and basically what it says if you use lifo for tax purposes if you&#39;re using glypho for IRS for tax purposes then you have to use lifo for external financial reporting so simply put you cannot have two sets of books you cannot say for tax I&#39;m gonna use lifo and for Gap I would use fifo you can do that if you use lifo4tax you have to use lifo4 Gap now if you use for tax you&#39;d use fifo you could use anything for Gap if for tax you would use the average you could use anything for Gap the Conformity is for lifo if you use lifo4 gap for tax you have to lose you have to use it for Gap because lifo save you taxes you cannot save taxes then use fifo and show higher income because fifos has a lower cost of goods sold well lifa has many issues we have to deal with and we&#39;re going to be dealing with in the next few sessions we&#39;re going to have to look apply for Reserve we can have to look at life for liquidation and we&#39;re going to have to look at dollar value lifo also in this session I did not cover the specific identification method I will cover it in a separate recording because those are assumptions

Transcript for:Cost Flow Assumptions

Transcript for:
Cost Flow Assumptions