AA015 Chapter 8

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Chapter 8:

Accounting For Inventories

CONTENTS

Definition of Inventories
Inventory System
Inventory Costing Methods
Effects of Inventory Valuation on Profit

8.1 DEFINITION OF INVENTORIES

- Goods held for sale in the normal course
of business

- 2 common characteristics:
1. owned by the business
2. in a form ready for sale to customers

Types of Inventory

1. Raw Materials
2. Work in Process
3. Finished Goods

▪ Although the inventory of raw materials
and work in process may not yet be ready
for sale, they are used to produce
products for resale purpose. Therefore,
they are classified as an inventory in
manufacturing company.

8.2 INVENTORY SYSTEM

1. Periodic System
2. Perpetual System

8.2.1 Periodic System

Product List

No entry is made at the time of sale
to record the cost of goods sold -
Updates inventory records only

periodically.

A physical inventory count is taken
at the end of the accounting period

to determine the cost of
ending inventory.

Purchased goods are recorded in
a Purchase Account.

8.2.2 Perpetual System

Obstacles

The ongoing physical flow of inventory
is monitored and cost of the inventory
items are maintained on a continuous basis

The cost of goods sold Purchase of
and the balance inventory
of inventory are
available at recorded directly
all time in

INVENTORY ACCOUNT

8.3 Inventory Costing Method

Table of contents

First-in, First-out
(FIFO)

Last-in, First-out
(LIFO)

Average Cost

(weighted average /
moving average)

8.3.1 First-in, First-out (FIFO)

❖Oldest items (IN) assumed to be sold
(OUT) first.

❖Ending inventory will consist of the most
recent items purchased.

❖The cost of the newest inventory items
remains in ending inventory.

❖The cost of the oldest inventory items is
charged to cost of goods sold when goods
are sold.

8.3.2 Last-in, First Out (LIFO)

❖Newest items (IN) are assumed to be sold
(OUT) first.

❖Ending inventory consist of oldest items in
inventory

❖The cost of newest inventory items is
charged to cost of goods sold when goods
are sold.

❖The cost of the oldest inventory items
remains in an ending inventory.

8.3.3 Average Cost

❖This method assumes that the goods available for
sale have the same (average) cost per unit,
generally, they are homogenous.

❖Cost of inventory per unit is computed by dividing
the total cost of goods available for sale
(COGAFS) by the total units available for sale.

❖Cost of ending inventory =

Ending inventory unit X weighted-average cost
per unit.
❖Periodic system: Weighted–average method
❖Perpetual system: Moving average

8.4 Effects of Inventory Valuation on

Profit

METHOD ENDING COST OF PROFIT TAX
INVENTORY GOODS
SOLD
First-In Highest Lowest Highest Highest
First-Out Lowest Lowest Lowest
Average Highest
method

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