LIFO, FIFO, and Weighted Average Made Easy
Many accounting students dread assigning costs to both inventory and cost of goods sold
, and some just do not know how to do all of the inventory methods. I am here to give a detailed step by step process on how to do each method: First in, First out, Last in, First out and Weighted Average.
First in, first out (FIFO) method is exactly how it sounds. The merchandise that comes in first, is the merchandise that is sold first. When something is being sold, the costs of the earliest merchandise purchased are charged to cost of goods sold. Lets say on April 1st, the inventory balance is $850 because the beginning balance consists of 10 sunglasses at $85 each. On April 5th, 12 more sunglasses are purchased for $95 each totaling to $1140. The purchase changes the inventory balance to $1990, and now consists 10 sunglasses at $85 each and 12 sunglasses at $95 each. On April 13th, 15 sunglasses are sold, which means the first 10 sunglasses cost $85 and the remaining 5 cost $95, selling a total of $1325 worth of sunglasses. The inventory balance only has 7 sunglasses left at $95 each, totaling at $665. On April 20th, 20 sunglasses are purchased for $2140 at $107 each. This once again changes the inventory balance to $2805, consisting of 7 sunglasses at $95 and 20 sunglasses at $107. On April 30th, 22 items are sold for $2270. The first 7 sunglasses are sold for $95 (the remaining 7 sunglasses from the April 5th purchase) and the remaining 15 sunglasses are sold for $107. The inventory balance contains only 5 sunglasses at $107 each, totaling to $535. At the end of April, we can find the cost of goods sold. In this case, On April 13th the cost of goods sold was $1325 and on April 30th the cost of goods sold was $2270, totaling the cost of goods sold for the month of April of $3595 ($1325+$2270=$3595).
Last in, first out (LIFO) method once again is exactly how it sounds. The merchandise that is purchased the most recent is sold first. Although it sounds very basic here, it does sometimes get tricky if it is not organized correctly. To demonstrate, we will use the same information we used for the first in, first out method, but we will use the last in, first out method instead. The inventory balance is $850 containing 10 sunglasses for $85 each. On April 5th, 12 more sunglasses are purchased for $1140 at $95 each; this changes the inventory balance to $1990. We can see that the inventory balance is exactly the same as when we did it during the first in, first out method because we have not sold anything yet. On April 13th, 15 sunglasses are sold. Instead of selling in the order they were acquired, they will be sold by the most recent purchase. The first 12 will cost $95 (from April 5th purchase) and the remaining 3 will cost $85 (from the beginning inventory) with a total cost of good sold of $1395. The inventory balance is now $595 containing 7 items costing $85 each. On April 20th, 20 sunglasses are purchased for $2140 costing $107 each. The inventory balance increases to $2735 containing 7 sunglasses at $85 each and 20 sunglasses at $107 each. On April 30, 22 sunglasses are sold for $2310. The first 20 sunglasses are sold for $107 each and the remaining 2 sunglasses are sold for $85 each. The inventory balance is now $425 containing only 5 of the original 10 sunglasses costing $85. At the end of the month of April, the cost of good sold is $3705 ($1395+$2310=$3705).
Weighted average is also called average cost. To find the cost for each sale, we use the weighted average cost per unit of inventory. To find the weighted average cost per unit per sale is easy. Basically, take cost of goods available for sale and divide it by the units available. Once again we will use the same example as the previous two, starting with the beginning balance of $850, with 10 sunglasses at $85. On April 5th, 12 more sunglasses are bought for $95 each, costing $1140. The inventory balance now consists of 10 sunglasses at $85 and 12 sunglasses at $95, for a total of $1990. The average cost per unit is computed by taking the inventory balance of $1990 and dividing it by the remaining 22 sunglasses equaling $90.45 ($1990/22=$90.45). Most likely the average cost per unit will have decimals, and it can be rounded since it is an average. On April 13th, 15 sunglasses are sold, and by using the average cost we just found, can give us the cost of goods sold (15 x $90.45), which is $1356.75. Now there is only 7 sunglasses remaining, and we will also use the $90.45 to compute the inventory balance (7 x $90.45=$633.15). On April 20th, 20 sunglasses are purchased at $107 each costing $2140. The inventory balance now equals $2773.15 with 7 sunglasses at $90.45 and 20 sunglasses at $107. The average cost per unit is now $102.71 (2773.15/27items). On April 30th, 22 sunglasses were sold for $102.71 each, costing 2259.62. Leaving only 5 sunglasses left at $102.71 equaling $513.55. The total cost of goods sold for the month of April is $3616.37 (1356.75+2259.62).
Notice that the LIFO method has a higher amount of cost of good sold compared to FIFO; which makes sense due to the fact that when selling using the LIFO method, the recent purchases normally cost more than the older purchases. And when using the weighted average method, the cost of good sold is in between LIFO and FIFO since we find the average cost per unit. And once we know the reason of the difference between costs of goods sold between each method, we successfully learned how to perform each inventory costing method!
LIFO, FIFO, and Weighted Average Made Easy
By: Shannon
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