Inventory cost accounting includes incidental fees such as administration, storage, and market fluctuation. GAAP (Generally accepted accounting principles) uses standardized accounting What is Inventory Cost Accounting.
It is part of the inventory control technique to ensure that the proper supply chain helps in reducing the total inventory costs and assist in determining the product for a company.
All these factors help the company to find out how much margin should be assigned to each product or product type. The approaches for cost accounting are:
Accounting Inventory Methods
Specific identification method: This method allows you to separately track the cost of every item in inventory and charge the particular cost of an item to the cost of goods sold when you sell the specific item to which that cost has been assigned.
This method requires a large amount of data tracking, so it is only used for very high-cost, unique items, such as automobiles or works of art. It is not a viable method in most other situations.
When you buy inventory from suppliers, the price changes over time, so you end up with a group of the same item in stock, but some units cost more than others.
As you sell items from stock, you need to decide on a policy whether to charge the items sold that were likely bought first, or last purchased or the average of all items in stock on a cost basis.
The policy of your choice will result in using either the first method (FIFO), the first last method (LIFO), or the weighted average method. The following bullet points illustrate every concept:
What are Sales of Product Income
First-in, first-out method: In the FIFO method, you are assuming that previously purchased items are also used or sold first, which also means that the items are still the newest ones in stock.
This policy closely matches the actual movement of inventories in most companies and is therefore simply superior from a theoretical point of view.
In a period of rising prices (which is the most frequent in most economies), assuming that the initial units purchased are used first, this also means that the least expensive units are sold at the cost of the goods previously sold. Is charged for.
This means that the cost of goods sold decreases, leading to higher operating income, and more income tax to be paid. Furthermore, this means that there are fewer inventory layers than the LIFO method (see next) because you will consistently use the oldest layers.
What is Cost of Goods Sold
Last in, first-out method. Under the LIFO method, you are assuming that the last purchased item has been sold before, which also means that the items are still the oldest in stock.
This policy does not follow the natural flow of inventory in most companies; In fact, this method is restricted under international financial reporting standards.
Assuming that the last units purchased have been used before, this also means that the cost of goods sold becomes higher, leading to lower operating income and lower-income taxes to pay.
There are more inventory layers than the FIFO method, as the oldest layers may not be flushed for years.
Weighted average method. Under the weighted average method, there is only one inventory layer, because the cost of any new inventory purchase is rolled into the cost of any existing inventory to obtain the new weighted average cost, which again after purchasing more inventory Is adjusted.
Cost of Goods Sold vs Inventory
The accountant records the difference in the cost of goods sold and inventory values as a part of their current assets.
Therefore, the ending inventory balance is recorded as a current asset on the balance sheet. When the inventory increases, the asset on the balance sheet also increases.
Also, when it decreases, the balance sheet’s current asset also decreases. The accountant records the change in inventory as a part of COGS.
Beginning Inventory + Net Purchases = Goods Available for Sale – Ending Inventory
The above COGS calculation is used by the accountant by adjusting some income statements.
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