The LIFO method proponents argue that the LIFO method improves the matching of revenues and replacement costs. However, the cost of ending inventory presented in the balance sheet presents older costs. More importantly, users of the LIFO method say that using LIFO gives them tax savings since they report a lower taxable income. If Corner Bookstore sells the textbook for $110, its gross profit using periodic FIFO will be $25 ($110 – $85).
In the illustration above, it’s OK if the four physical paddles in beginning inventory were sold during the year. A company can still assign costs to ending inventory assuming the four paddles are still physically in the inventory. 1Because ending inventory for one period becomes the beginning inventory for the next, application of a cost flow assumption does change that figure also. However, the impact is only indirect because the number is simply carried over from the previous period. No current computation of beginning inventory is made based on the cost flow assumption in use.
Inventory and Cost of Goods Sold Outline
The $85 cost that was assigned to the book sold is permanently gone from inventory. If XYZ Ltd uses the periodic inventory system, the ending inventory is computed as the sum of beginning inventory and total purchases during the accounting period less number of units sold. The ending inventory of 43,000 units consists of 35,000 units from the beginning inventory at a cost of $150 per unit and purchase made on 12th of February of 8,000 units at a cost of $175 per unit. Thus, the inventory account balance totals $7,310,000 at the end of the first quarter. The bad news is the periodic method does do things just a little differently.
Most companies using periodic inventory systems are small businesses that only count inventory and calculate COGS once per year. However, if you want to use the periodic inventory system monthly, you can estimate the units in ending inventory without taking a physical count. ABC International acquires 10 green widgets on January 15 for $5, and acquires another 10 green widgets at the end of the month for $7. The only difference between the two cost flow concepts is how rapidly a cost layer is stripped away or replenished in the costing database. Under perpetual LIFO, there can be a great deal of this activity throughout a reporting period, with inventory layers being added and eliminated potentially as frequently as every day. This means that the costs at which items are sold could vary throughout the period, since costs are being drawn from the most recent of a constantly varying set of cost layers.
Example – LIFO periodic system in a merchandising company:
Under the periodic inventory method, cost of goods sold is calculated at the end of the period only and recorded in one entry. In the perpetual inventory system, a sale requires two entries in the general journal. The first should be recorded by debiting accounts receivable and crediting sales account by sales value. The second should be recorded by debiting cost of goods sold account and crediting the inventory account by the cost of inventory. The last-in, first-out (LIFO) method is one of the three inventory cost flow assumptions, alongside the FIFO (first-in, first-out) and average cost methods.
Let’s assume that RetailPro Ltd is a retailer selling only one product. Under the LIFO Method, cost of goods sold is calculated using the most recent inventory first and then working our way backwards until the sales order has been filled. Under the perpetual inventory system, we determine the COGS and inventory after every sale instead of waiting until the end of the year. This requires much more work and is only recommended if you use inventory management software that can integrate with your accounting software. InFlow is an inventory management software that can use LIFO and integrate with popular accounting software like QuickBooks Online and Xero.
Example – LIFO periodic system in a manufacturing company:
Let’s explore the LIFO method and discover if this is the best fit for your inventory needs. You can learn about other methods of tracking inventory costs in our guide to cost of goods sold (COGS). Two bathtubs were sold on September 9 but the identity of the specific costs to be transferred depends on the date on which the determination is made. A periodic system views the costs from the perspective of the end of the year, while perpetual does so immediately when a sale is made. Mayberry Home Improvement Store reports gross profit using periodic LIFO of $902 (revenue of $1,950 less cost of goods sold of $1,048).
- 1Because ending inventory for one period becomes the beginning inventory for the next, application of a cost flow assumption does change that figure also.
- The ending inventory under LIFO would, therefore, consist of the oldest costs incurred to purchase merchandise or materials inventory.
- Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
- Since the specific identification method, identifies exactly which cost the purchase comes from it does not change under perpetual or periodic.
- After determining the cost of goods sold, cost of inventory is determined to deduct the cost of goods sold from the cost of goods available for sale.
Each time this figure is found by dividing the number of units on hand after the purchase into the total cost of those items. One cost $110 while the other three were acquired for $120 each or $360 in total. Total cost was $470 ($110 + $360) for these four units for a new average of $117.50 ($470/4 units). The applicable average at the time of sale is transferred from inventory to cost of goods sold at points A ($110.00), B ($117.50), and C ($126.88) below. According to a physical count, 1,300 units were found in inventory on December 31, 2016.
The average cost of $88 is used to compute both the cost of goods sold and the cost of the ending inventory. The Periodic inventory system is also called a traditional inventory system. According to this system, the physical counting of inventory is made at the end of a certain period.
After determining the cost of goods sold, cost of inventory is determined to deduct the cost of goods sold from the cost of goods available for sale. Under the periodic inventory system, it is difficult to determine the surplus and spoil of the inventories. Also, the cost of goods sold and the cost of ending inventory are the transactions they cannot be determined under this system. However, this system is easy to adopt and competitively this system has a low cost of operation. The periodic inventory system requires a physical count of inventory at the end of the period.
The six inventory systems shown here for Mayberry Home Improvement Store provide a number of distinct pictures of ending inventory and cost of goods sold. As stated earlier, these numbers are all fairly presented but only in conformity with the specified principles being applied. Note here that the anticipated characteristics of LIFO are present. Ending inventory of $440 is lower than that reported by FIFO ($558). Cost of goods sold ($1,048) is higher than under FIFO ($930) so that the reported gross profit (and, hence, net income) is lower by $118 ($1,020 for FIFO versus $902 for LIFO).
Under a periodic LIFO system, however, layers are only stripped away at the end of the period, so that only the very last layers are depleted. In a periodic LIFO system, inventory records are only updated at the end of a reporting period. During the month ABC Company sold 2000 units @ Rs. 12 per unit. The corporate tax rate is 30%, and the administrative expenses are Rs. 2,000. As of March 31, the ending inventory is $6,650,000, and the cost of goods sold is $38,425,000. The cost of goods sold in the first quarter totaled $38,425,000.