Basic Inventory Accounting (FIFO, LIFO, Weighted Average)

Introduction to Inventory Accounting

Inventory accounting determines:

Cost of goods sold (COGS)
Ending inventory value
Gross profit

Critical for:

Financial statement accuracy
Tax planning
Management decision-making

Why Inventory Methods Matter

Financial impact: Different methods = different profits
Tax implications: LIFO can reduce taxable income in inflation
Exam frequency: Consistently tested in multiple choice and simulations
Real-world relevance: Used by businesses daily

Inventory Flow Assumptions

Three primary methods:

FIFO: First-In, First-Out
LIFO: Last-In, First-Out
Weighted Average: Average cost of all units

Note: Physical flow ≠ Cost flow assumption

Inventory Systems

Periodic System:

Count inventory at period end
Calculate COGS indirectly

Perpetual System:

Track inventory continuously
Calculate COGS directly with each sale

FIFO: First-In, First-Out

Core concept: Oldest inventory items sold first

Mnemonic: "FIFO Freshens Inventory First, Oldest out"

Advantages:

Matches physical flow in many businesses
Ending inventory reflects current costs
Higher profits during inflation

Disadvantages:

Higher taxable income during inflation
Less matching of current costs with current revenue

FIFO Example

Inventory transactions:

Jan 5: 100 units @ $10 = $1,000
Jan 15: 150 units @ $12 = $1,800
Jan 25: 200 units @ $15 = $3,000

If 300 units are sold, what is the COGS and ending inventory under FIFO?

FIFO Example Solution

COGS calculation:

100 units from Jan 5 @ $10 = $1,000
150 units from Jan 15 @ $12 = $1,800
50 units from Jan 25 @ $15 = $750
Total COGS = $3,550

Ending inventory:

150 units from Jan 25 @ $15 = $2,250

Note: Ending inventory reflects most recent costs

Instructor Script

Introduction to Inventory Accounting

Welcome back to QuickFire CPA! Today we're diving into Basic Inventory Accounting - a topic that might seem straightforward but trips up countless CPA candidates every year.

Inventory accounting is all about determining three critical numbers: your cost of goods sold (or COGS), your ending inventory value, and ultimately your gross profit. Get these wrong, and everything from your income statement to your balance sheet falls apart.

I remember my first accounting job at a retail company where the CFO told me, "Get the inventory right, and half your job is done." He wasn't exaggerating! Let's make sure you nail this topic on exam day.

Why Inventory Methods Matter

So why should you care about inventory methods beyond just passing the exam?

First, different methods can dramatically impact your financial statements. In periods of rising prices, your choice of inventory method could mean the difference between showing a profit or a loss.

Second, there are significant tax implications. Companies often choose LIFO specifically to reduce their tax burden during inflationary periods - a perfectly legal strategy that can save millions.

Third, this topic appears consistently on the exam in both multiple-choice questions and simulations. The calculations are straightforward once you understand the concepts, making these some of the easiest points you can score.

And finally, this isn't just theoretical - businesses use these methods every single day. Understanding them gives you practical knowledge you'll use throughout your accounting career.

Inventory Flow Assumptions

There are three primary inventory methods you need to know for the exam:

FIFO, or First-In, First-Out
LIFO, or Last-In, First-Out
And Weighted Average

Here's a critical point that confuses many candidates: The physical flow of inventory doesn't have to match the cost flow assumption. A company could physically move their newest inventory first but still use FIFO for accounting purposes. These are accounting methods, not warehouse management systems!

Practice Questions

Question 1

Company ABC has the following inventory transactions:

Beginning inventory: 200 units @ $8 = $1,600
Purchase 1: 300 units @ $10 = $3,000
Purchase 2: 100 units @ $12 = $1,200

If 400 units are sold, what is the ending inventory value under FIFO?

A) $1,200
B) $1,600
C) $2,000
D) $2,400

Answer: C) $2,000

Calculation:

Under FIFO, we sell the oldest units first:
We sell the 200 units from beginning inventory: 200 units @ $8 = $1,600
Then 200 units from Purchase 1: 200 units @ $10 = $2,000
Total COGS = $3,600
Ending inventory consists of:
100 units remaining from Purchase 1: 100 units @ $10 = $1,000
100 units from Purchase 2: 100 units @ $12 = $1,200
Total ending inventory = $2,000

Question 2

Company XYZ uses the perpetual inventory system and has the following data:

Beginning inventory: 0 units
January 10: Purchase 100 units at $20
January 15: Sell 60 units
January 20: Purchase 80 units at $25
January 25: Sell 70 units

What is the ending inventory value under perpetual LIFO?

Answer: $1,050

Calculation:

Jan 10: Purchase 100 units @ $20 = $2,000
Jan 15: Sell 60 units @ $20 = $1,200 (COGS)
Remaining: 40 units @ $20 = $800
Jan 20: Purchase 80 units @ $25 = $2,000
Inventory: 40 units @ $20 + 80 units @ $25 = $2,800
Jan 25: Sell 70 units (70 from newest purchase @ $25) = $1,750 (COGS)
Ending inventory: 40 units @ $20 + 10 units @ $25 = $1,050