ACCT1001 · Financial Accounting 1
Inventory
Inventory has one physical stock but several ways to put a cost on it, and ACCT1001 tests the mechanics and the choices. Two questions set up the whole topic: which system (perpetual, which updates after every transaction, vs periodic, which counts at period end) and which cost-flow assumption (FIFO — first in, first out; or weighted average cost). The same purchases and sales give different cost of goods sold and different closing inventory depending on the assumption, and in a period of rising prices FIFO reports a lower COGS and higher profit than weighted average. On top of cost sits the AASB 102 valuation rule: inventory is carried at the lower of cost and net realisable value, so when NRV falls below cost the stock is written down and the loss is recognised immediately. The chapter also covers inventory errors (which self-correct over two periods) and the inventory turnover ratio. You must be able to compute COGS and closing inventory under FIFO and weighted average, in both perpetual and periodic systems, and apply the lower-of-cost-and-NRV test.
What this chapter covers
- 015.1 Why cost-flow is a choice at all
- 025.2 Two questions: which system (perpetual vs periodic) and which cost flow
- 035.3 FIFO — first in, first out
- 045.4 Weighted average cost
- 055.5 The rising-prices effect (FIFO vs WAC on COGS & profit)
- 065.6 Lower of cost and net realisable value (AASB 102)
- 075.7 Inventory errors & the inventory turnover ratio
Worked example: FIFO closing inventory and COGS (periodic)
- +1Total units available: 10 + 20 + 10 = 40 units; cost available = (10×$4) + (20×$5) + (10×$6) = $40 + $100 + $60 = $200.
- +2FIFO sells the oldest first: the 30 sold = 10@$4 + 20@$5 = $40 + $100 = $140 → this is COGS.
- +1Closing inventory = newest units left: 40 − 30 = 10 units remain, all from the last purchase = 10@$6 = $60.
- +1Check: COGS $140 + closing inventory $60 = $200 = cost of goods available — the figures reconcile.
Key terms
- FIFO (first in, first out)
- A cost-flow assumption that charges the oldest costs to cost of goods sold first, leaving the most recent costs in closing inventory. In a period of rising prices FIFO gives a lower COGS, a higher closing inventory, and a higher reported profit than weighted average.
- Weighted average cost
- A cost-flow assumption that costs each unit at the average cost of all units available. Under the periodic system the average is struck once at period end; under perpetual it is recalculated after each purchase (the moving average). It smooths price changes between FIFO's extremes.
- Net realisable value (NRV)
- The estimated selling price of inventory in the ordinary course of business, less the estimated costs to complete and sell it. Under AASB 102, inventory is carried at the lower of cost and NRV, so a fall in NRV below cost triggers an immediate write-down.
- Lower of cost and NRV
- The AASB 102 valuation rule: inventory is reported at whichever is lower, its cost or its net realisable value. It is an application of prudence — losses from a fall in value are recognised at once, while gains are not anticipated. The write-down increases cost of goods sold (or a separate expense).
- Inventory turnover
- A ratio measuring how many times inventory is sold and replaced in a period: cost of goods sold divided by average inventory. A higher turnover generally signals efficient stock management; a falling turnover can warn of slow-moving or obsolete stock that may need an NRV write-down.
Inventory FAQ
What is the difference between perpetual and periodic systems?
Perpetual updates the Inventory and Cost of Goods Sold accounts after every purchase and sale, so the balances are known continuously. Periodic does not touch a perpetual inventory account during the period; instead COGS is calculated at period end as opening inventory plus purchases minus closing inventory (from a physical count). The choice of system and the cost-flow assumption (FIFO or weighted average) are two separate decisions, and the exam can combine them.
Why does FIFO give a higher profit than weighted average when prices rise?
Because FIFO charges the oldest, cheapest costs to cost of goods sold, leaving the newest, dearer costs in closing inventory. A lower COGS means a higher gross profit and a higher closing inventory value. Weighted average blends old and new costs, so its COGS is higher and its profit lower than FIFO's in a rising-price period. When prices fall, the relationship reverses.
When do I write inventory down, and by how much?
When net realisable value falls below cost. AASB 102 requires inventory to be carried at the lower of cost and NRV, so you compare the two for each item (or group) and, if NRV is lower, write the inventory down to NRV. The write-down — cost minus NRV — is recognised as an expense in the period it occurs; you never write inventory up above its original cost.
Do inventory errors matter if they self-correct?
They matter within each period even though they wash out over two. An error in closing inventory misstates this period's cost of goods sold and profit in one direction, and next period's in the opposite direction (because this period's closing inventory is next period's opening inventory). Over two periods the total profit is correct, but each individual period's profit and the balance sheet are wrong — which is exactly what an exam question tests.
Exam move
Build a clean working for FIFO and weighted average and reuse it every time: list units and costs available, apply the assumption to find cost of goods sold, then back out closing inventory and check that COGS plus closing inventory equals goods available. Practise the same data under both perpetual and periodic, because the answers can differ (especially for moving-average), and know the rising-prices result cold (FIFO → lower COGS, higher profit). Always finish with the lower-of-cost-and-NRV test — it is a frequent add-on mark. Keep the inventory-error logic straight (this period's closing inventory is next period's opening inventory) and be ready to compute and interpret inventory turnover.
