Overview

This topic explains how businesses account for inventory and calculate the cost of goods sold (COGS). You'll learn about inventory systems, cost flow assumptions, and the impact of inventory valuation on financial statements.

Key Concepts and Methods

• Inventory: Goods held for sale or production. Reported as a current asset on the balance sheet.
• COGS: Direct costs of inventory sold during a period. Affects gross profit and net income.
• Inventory Systems:
  • Perpetual: Continuously updated after each transaction
  • Periodic: Updated at end of accounting period using physical count
• Cost Flow Assumptions:
  • FIFO: First in, first out
  • LIFO: Last in, first out
  • Weighted Average: Average cost per unit
• Lower of Cost or Market (LCM): Inventory must be reported at the lower of historical cost or market value.

Step-by-Step Example

Problem: A company using FIFO had 100 units in beginning inventory at $10 each. During the month, it purchased 200 units at $12. It sold 150 units. What is COGS?

Step 1: Under FIFO, sell earliest inventory first:
- 100 units @ $10 = $1,000
- 50 units @ $12 = $600

Step 2: Add the two amounts:
COGS = $1,000 + $600 = $1,600

Answer: COGS = $1,600

Quick Tip