22208 Chap.6 Inventory: Cost Flows, Errors and Estimates
Inventory: Cost Flows, Errors and Estimates
Week 6 covers inventory, a tangible resource held for resale and recorded at every cost needed to make it ready for sale, less returns and discounts. A perpetual system updates cost of goods sold with every sale; under the periodic system it is calculated at period end. FIFO, LIFO and weighted average assign different costs to cost of goods sold.
The topic also covers counting errors, the gross profit method of estimating stock and the lower of cost and net realisable value.
Questions here are table-driven. You are given an opening balance and a run of purchases and sales, and must cost each sale and the closing stock under FIFO or weighted average, sometimes under both systems, then record the journal entries.
Shorter items test what belongs in inventory cost, how a supplier allowance or discount is recorded, the effect of a counting error on two years’ profit, and a write-down to net realisable value.
What this chapter covers
- 01
Costs included in inventory: freight in, returns, discounts
- 02
Perpetual and periodic inventory systems
- 03
Two entries for every perpetual sale
- 04
FIFO and moving weighted average costing
- 05
Periodic costing from a stock count
- 06
Counterbalancing inventory errors
- 07
Gross profit method and lower of cost and NRV
Worked example · free
Estimating stock lost in a flood
- 1Estimated gross profit: 180,000 × 35% = $63,000.
- 1Estimated cost of goods sold: 180,000 − 63,000 = $117,000.
- 1Goods available for sale: 42,000 + 96,000 = $138,000.
- 1Estimated ending inventory: 138,000 − 117,000 = $21,000.
Key terms
- Perpetual inventory system
- A system that updates inventory and cost of goods sold every time goods are bought or sold.
- Cost of goods sold
- The cost of the inventory sold in a period, reported as an expense on the income statement.
- FIFO
- A costing method that assigns the cost of the oldest units to goods sold first.
- Weighted average cost
- A costing method that charges each unit at the average cost of the units available.
- Gross profit method
- An estimate of ending inventory that uses the usual gross profit percentage to approximate cost of goods sold.
Inventory: Cost Flows, Errors and Estimates FAQ
Why does FIFO give a higher profit when prices are rising?
FIFO sends the oldest, cheapest units to cost of goods sold, so the expense is lower and profit higher. The newer, dearer units stay in ending inventory, which is why FIFO also reports the highest closing stock.
Is LIFO allowed in Australia?
The lecture notes that LIFO is not used for reporting or tax in Australia. It appears in this subject to show the range of outcomes, with FIFO and weighted average as the methods applied in practice.
What is a counterbalancing inventory error?
It is a counting error whose effect on profit reverses in the next period. An overstated closing inventory understates cost of goods sold and overstates profit, then becomes next year’s opening inventory and has the opposite effect.
Are freight costs part of inventory?
Freight paid to bring goods into the business, often called transportation-in, is part of inventory cost under the cost principle, together with duties and transit insurance. Supplier allowances and early-payment discounts reduce the cost recorded in the inventory account.
When would a business estimate inventory instead of counting it?
When a count is impossible or impractical, for example after stock is destroyed by fire or flood, or for interim reports. The gross profit method uses the usual gross profit percentage to estimate cost of goods sold and then the inventory that should remain.
Exam move
Lay out every costing question as a three-column table of purchases, sales and balance on hand, and check that cost of goods sold plus ending inventory equals goods available. Rehearse the two entries for each perpetual sale and the gross profit estimate until both are routine. Under time pressure, check every costing answer with one line: goods available equals cost of goods sold plus ending inventory.
If it fails, recount the units before touching the dollars. Practise one question under the periodic system as well, since the order of sales stops mattering there, and finish with a lower of cost and net realisable value comparison done item by item so that losses are never offset by gains.
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