Inventory Costing: Same Goods, Four Different Stories
Inventory costing can seem like four completely different problems. It isn't.
The company has one pool of inventory costs. The costing method determines how that cost is divided between Cost of Goods Sold and Ending Inventory.
The Big Idea
Before thinking about dollars, start with the units.
How many units were available? How many were sold? How many must still be in Ending Inventory?
The units do not change when the costing method changes.
What changes is which costs are assigned to those sold and unsold units.
One Inventory Pool
A retailer has the following inventory available during the period:
During the period, the company sells 90 units.
Stop Here Before Doing Any Costing
Units Available
Units Sold
Units Remaining
Every method must assign costs to exactly 90 sold units and exactly 60 remaining units.
Specific Identification: Which Exact Items Were Sold?
Specific Identification does not make a cost-flow assumption. It uses the actual costs of the specific units sold.
Suppose the company can identify that the 90 units sold were:
Reveal the Specific Identification solution
Cost of Goods Sold
Ending Inventory
The remaining units are:
FIFO: Oldest Costs Leave First
FIFO assigns the oldest costs to Cost of Goods Sold first.
We need to assign costs to 90 sold units and leave costs assigned to 60 units in Ending Inventory.
Reveal the FIFO solution
Cost of Goods Sold
Ending Inventory
After assigning the oldest costs to COGS, 60 units remain:
LIFO: Newest Costs Leave First
LIFO assigns the newest costs to Cost of Goods Sold first.
Reveal the LIFO solution
Cost of Goods Sold
Ending Inventory
The oldest costs remain:
Weighted Average: Blend the Cost Pool
Weighted Average does not select particular layers. It spreads the total cost across all units available.
Reveal the Weighted-Average solution
Cost of Goods Sold
Ending Inventory
Now Compare the Four Methods
Before opening the table, think about what you just calculated. Which method produced the highest COGS? Which produced the highest Ending Inventory?
Reveal the comparison table
| Method | COGS | Ending Inventory | Total |
|---|---|---|---|
| Specific Identification | $1,090 | $730 | $1,820 |
| FIFO | $1,000 | $820 | $1,820 |
| LIFO | $1,180 | $640 | $1,820 |
| Weighted Average | $1,092 | $728 | $1,820 |
The method changes the split. It does not change the $1,820 of total cost available.
What Do You Notice About Rising Costs?
In this example, unit costs increased from $10 to $12 to $14.
Before revealing the explanation, use your FIFO and LIFO answers to predict which method produced higher COGS and which produced higher Ending Inventory.
Reveal the pattern
FIFO
Older, lower costs moved to COGS first.
That produced the lower COGS and higher Ending Inventory.
LIFO
Newer, higher costs moved to COGS first.
That produced the higher COGS and lower Ending Inventory.
Cost Flow Is Not Necessarily Physical Flow
FIFO and LIFO tell us which costs are assigned to sold units.
They do not necessarily tell us which physical items were actually taken off the shelf and sold.
One More Step: Lower of Cost or Market
Now use the FIFO result you calculated above.
FIFO Ending Inventory at cost was $820. Suppose the market amount for that inventory at year-end is $760.
Reveal the LCM solution
The required write-down is:
Common Inventory Costing Traps
FIFO means the oldest physical merchandise was definitely sold first. Tap to check
FIFO is a cost-flow assumption. It assigns the oldest costs to COGS first.
Different costing methods change the total cost of goods available. Tap to check
Every method starts with the same cost pool. The methods change only how that cost is divided between COGS and Ending Inventory.
Weighted Average means averaging $10, $12, and $14. Tap to check
The quantities matter.
Weighted-average cost uses total cost of goods available divided by total units available.
Specific Identification means choosing whichever costs produce the desired answer. Tap to check
Specific Identification uses the actual identified cost of the specific units sold and remaining.
Lower of Cost or Market replaces FIFO, LIFO, or Weighted Average. Tap to check
First determine inventory cost using the applicable costing method. LCM then considers whether the recorded inventory amount needs to be reduced.
Once COGS is calculated, there is no reason to calculate Ending Inventory. Tap to check
The two amounts provide a built-in check:
COGS + Ending Inventory = Cost of Goods Available for Sale.
If You Remember Only Four Things...
Start with units before dollars.
The methods allocate the same total cost pool.
COGS + Ending Inventory must equal cost available.
LCM comes after determining inventory cost.