Inventory cost-flow methods

Learning goals

• Compute ending inventory and cost of goods sold under FIFO, weighted average, and specific identification.
• Distinguish periodic weighted average from perpetual moving average.
• Explain how changing costs affect profit, assets, and ratios.
• Explain LIFO's curriculum history and current IFRS restriction.

Prerequisite check

Goods available for sale must be split between ending inventory and cost of goods sold. Therefore beginning inventory + purchases = ending inventory + cost of goods sold. If your two calculated outputs do not equal goods available, stop and find the error.

Vocabulary

• Cost-flow assumption: rule assigning available costs to units sold and remaining.
• FIFO: earliest costs are assigned to cost of goods sold first.
• Weighted-average cost: total cost available divided by units available.
• Moving average: new average recalculated after each perpetual purchase.
• Specific identification: actual tracked cost assigned to each distinct item.
• LIFO: latest costs assigned to cost of goods sold first; historical comparison only.

Core idea

Cost-flow assumptions allocate costs; they need not describe the physical shelf flow. Use the same method consistently for similar inventory unless a justified change better represents information. LIFO may appear in the legacy Ontario curriculum, but LIFO is not permitted under IFRS Accounting Standards and is not a current Canadian reporting choice for this course's entries.

Why this treatment makes sense

Identical items bought at different prices cannot all carry a single obvious cost after they are mixed. A systematic method makes the allocation reproducible. FIFO leaves recent costs in ending inventory; weighted average smooths price changes; specific identification is useful when distinct high-value items can be tracked reliably.

A repeatable method

1. List units and unit costs by purchase layer.
2. Confirm total units and total cost available.
3. Calculate units sold and units ending.
4. Apply the named method—never mix rules mid-schedule.
5. Verify COGS + ending inventory = cost available.
6. Explain the statement effect using the direction of purchase-price changes.

Worked example

Table: Periodic inventory data for Northern Mug Co.

The company sells 180 units, leaving 70.

FIFO: COGS = 100 × $10 + 80 × $12 = $1,960. Ending inventory = 70 × $12 = $840.

Periodic weighted average: average = $2,800 ÷ 250 = $11.20. COGS = 180 × $11.20 = $2,016. Ending inventory = 70 × $11.20 = $784.

The check works in both cases: $1,960 + $840 = $2,800 and $2,016 + $784 = $2,800. With rising costs, FIFO reports lower COGS and higher profit and ending inventory than weighted average in this example.

For a perpetual moving average, recalculate the unit average after each purchase and use the current average at each sale; a year-end average may give a different result.

Journal, ledger, and statement connection

Under a perpetual system, a FIFO sale debits Cost of Goods Sold and credits Inventory for the assigned layer cost. Under a periodic system, cost flow is reflected through the period-end inventory and closing process rather than a cost entry at each sale. Higher ending inventory means lower COGS, higher profit, higher equity, and higher assets.

Common mistakes

• Applying FIFO to selling prices instead of costs.
• Using units purchased instead of units available in the weighted-average denominator.
• Rounding the average too early and creating an avoidable reconciliation difference.
• Using one periodic year-end average for a moving-average question.
• Presenting LIFO as an acceptable IFRS policy because it remains named in the 2006 curriculum.

Guided practice

Available inventory is 40 units at $20 and 60 at $25; 75 units are sold. Under FIFO, COGS = 40($20) + 35($25) = $1,675; ending inventory = 25($25) = $625. Total cost available is $2,300, and the check is $1,675 + $625.

Independent practice

Inventory consists of 50 units at $8 and 70 units at $11. The company sells 90 units.

1. Compute FIFO COGS and ending inventory.
2. Compute periodic weighted-average COGS and ending inventory; carry average cost to four decimals.
3. Which method produces higher profit when sales revenue is fixed? Explain.
4. When would specific identification be more credible than averaging?

Self-check and solutions

1. Available cost = $400 + $770 = $1,170. FIFO COGS = 50($8) + 40($11) = $840; ending inventory = 30($11) = $330.
2. Average = $1,170 ÷ 120 = $9.75. COGS = 90($9.75) = $877.50; ending = $292.50.
3. FIFO produces $37.50 higher profit because its COGS is $37.50 lower while costs are rising.
4. For distinct, traceable items such as serialized custom equipment or vehicles, provided management cannot select costs opportunistically.

Retrieval practice

1. What invariant checks every cost-flow schedule?
2. Under rising costs, which costs remain under FIFO?
3. Is LIFO permitted by IFRS?

Answers: COGS + ending inventory = cost available; newer costs; no.

Exam-style application

A manager wants to switch from weighted average to FIFO solely to increase this year's profit before a bonus is calculated. Give an accounting and an ethical response.

Model response: A method change requires a supportable reporting reason and consistent application, not just a desired outcome; quantify and disclose effects as required by the applicable framework. The bonus pressure creates bias, so the accountant should document the analysis and escalate approval rather than manipulate policy.

Lesson summary

Cost-flow methods allocate the same cost pool differently. Show the layers, perform the invariant check, connect cost direction to statements, and keep LIFO in its proper place as a non-IFRS historical comparison.