Calculation of COGS and Value of Ending Inventory

Financial Reporting and Analysis

LOS C and D requires you to:

c. calculate and compare the cost of sales, gross profit, and ending inventory using different inventory valuation methods and using the perpetual and periodic inventory systems,

and

d. calculate and explain how inflation and deflation of inventory costs affect the financial statements and ratios of companies that use different inventory valuation methods.

The calculation of the cost of goods sold and the value of ending inventory can be explained with the help of the following example:

The goods are purchased and sold by a trader in the course of his business as follows:

Purchases were:

Date	Quantity	Price
1-Jan	200	50
7-Jan	270	52
26-Jan	350	51

And the units were sold as follows:

Date	Quantity	Price
05-Jan	100	60
27-Jan	500	64

The balances in the inventory account on the relevant dates, according to the FIFO method would be:

Date	Quantity	Price	COGS	Balance
01-Jan	200	50		$ 10,000
05-Jan	-100	60	$ 5000 (i.e. $50 × 100)	$ 5,000
07-Jan	270	52		$ 19,040 (i.e. $ 50 × 100 + 270 × 52)
26-Jan	350	51		$ 36,890 (i.e. $19,040 + 350 × 51)
27-Jan	-500	64	$ 25,670 (i.e. $ 19,040+ $ 51 × 130)	$ 11,220 (i.e. $ 51 × 220)

Under LIFO the cost of goods sold and value of inventory would be calculated as follows:

Date	Quantity	Price	COGS	Balance
01-Jan	200	50		$ 10,000
05-Jan	-100	60	$ 5000 (i.e. $50 × 100)	$ 5,000
07-Jan	270	52		$ 19,040 (i.e. $ 50 × 100 + 270 × 52)
26-Jan	350	51		$ 36,890 (i.e. $19,040 + 350 × 51)
27-Jan	-500	64	$ 25,650 (i.e. $ 51 × 350+ $ 52 × 150)	$ 11,240 (i.e. $ 52 × 120 + 50 × 100)

Under the weighted average cost method the valuation would be done as follows:

Date	Quantity	Average Price of Balance Inventory	COGS	Balance
01-Jan	200	50		$ 10,000
05-Jan	-100	60	$ 5000 (i.e. $50 × 100)	$ 5,000
07-Jan	270	51.46 (i.e. 19040/370)		$ 19,040
26-Jan	350	51.24 (i.e. 36890/720)		$ 36,890
27-Jan	-500	51.24	$ 25,618 (i.e. $51.24 × 500)	$ 11,272 (i.e. $ 51.24 × 220)

Therefore, under the three methods, the value of the cost of goods sold and ending inventories would be:

	Ending Inventory	COGS	Total
FIFO	$ 11,120	$ 30,670 (i.e. 5,000 + 25,670)	$ 41,890
LIFO	$ 11,240	$ 30,650 (i.e. 5,000 + 25650)	$ 41,890
Weighted Average	$ 11,272	$ 30,618 (i.e. 5,000 + 25,618)	$ 41,890

And, the amount of profits under three methods would be as follows:

Particulars	FIFO	LIFO	Average Cost
Sales	$ 38,000	$ 38,000	$ 38,000
Less: COGS	$ 30,670	$ 30,650	$ 30,618
Gross Profit	$ 7,330	$ 7,350	$ 7,382

1. Impact of Inflation / Deflation on Valuation of Inventory

When the prices are rising:

a. the cost of goods sold would be higher under the LIFO method as compared to the weighted average cost method, and the same would be least under the FIFO method; and

b. the value of ending inventory would be higher under the FIFO method than the weighted average cost method and would be lowest under the LIFO method.

Or, we can say:

When the prices are rising
COGS	LIFO > AVCO > FIFO
Ending Inventory	FIFO > AVCO > LIFO

Thus we can say that when the prices are rising:

i. LIFO method and AVCO method understates the value of ending inventory in comparison to the FIFO method, and

ii. FIFO and AVCO methods understate the value of the cost of goods sold (thus overstating the value of gross profits) in comparison to the LIFO method.

When the prices are falling:

a. the cost of goods sold would be higher under the FIFO method as compared to the weighted average cost method, and the same would be least under the LIFO method; and

b. the value of ending inventory would be higher under the LIFO method than the weighted average cost method and would be lowest under the FIFO method.

Or, we can say:

When the prices are falling:
COGS	FIFO > AVCO > LIFO
Ending Inventory	LIFO > AVCO > FIFO

Thus we can say that when the prices are falling:

i. LIFO method and AVCO method overstates the value of ending inventory in comparison to the FIFO method, and

ii. FIFO and AVCO methods overstate the value of the cost of goods sold (thus understating the value of gross profits) in comparison to the LIFO method.