A Valuation Calculations
This appendix contains these topics:
A.1 First In/First Out (FIFO) Calculations
The FIFO costing method assumes that the first inventory items purchased are the first ones sold. This method results in an ending inventory balance based on the costs associated with the most recent purchases. The allocated ending inventory and value become the opening inventory for the next period.
The following example demonstrates the FIFO principle using the first five and last months of a fiscal year.
The example does not include the other factors, such as freight, exchange rate differences, and loans and borrows, that can affect the cost of the inventory.
Figure A-1 First In/First Out (FIFO) Calculations
Description of "Figure A-1 First In/First Out (FIFO) Calculations"
The opening inventory quantity and price for Pool 1 for the month of January is the closing inventory from December of the previous year. In January, the company purchased a total of 1400 units for 2800.00. The company sold 900 units.
The system uses the following formula to calculate the closing inventory units:
Opening inventory (500) + purchases (1400) - sales (900) = closing inventory (1000)
In determining the closing inventory value using FIFO, the system allocates the closing inventory quantity to the most recently purchased quantities. Because this costing method specifies that the inventory purchased first is sold first, the system calculates the closing inventory as follows:
Once properly allocated, the system calculates the closing inventory value by multiplying the closing allocations by the respective purchase price and summing:
Closing inventory value = sum (closing allocations * purchase price)
Closing inventory value (January) = (600 * 1.75) + (300 * 2.50) + (100 * 2.00) = 2000.00
Once the system determines the closing inventory, then it calculates the cost of the goods sold (COGS) using the formula:
Opening inventory value (500.00) + purchases (2800.00) - closing inventory value (2000.00) = COGS (1300.00)
The system calculates the cost of the closing inventory per unit as follows:
Closing inventory value (2000.00) / total closing inventory(1000) = 2.00
The January closing inventory becomes the February opening inventory. February through May follow the same calculation formulas as illustrated in the following tables:
Figure A-3 February Through May Inventory Calculations
Description of "Figure A-3 February Through May Inventory Calculations"
The closing inventory quantity allocation is as follows:
Figure A-4 Closing Inventory Quantity Allocation
Description of "Figure A-4 Closing Inventory Quantity Allocation"
For simplicity, this example assumes the company made no transactions from June through November.
Figure A-8 June Through November Closing Inventory
Description of "Figure A-8 June Through November Closing Inventory"
The system calculates the following end-of-year values as follows:
Closing inventory value = (100 * 1.48) + (1200 * 1.35) + (1500 * 1.50) = 4018.10
Closing inventory cost per unit = 4018.10 / 2,800 = 1.44
The system calculates the COGS for December as follows:
COGS (December) = 3110.00 + 3870.00 - 4018.10 = 2961.90
Using these calculations, the opening inventory values for January are:
| Description | Value |
|---|---|
| Inventory Quantity | 2800 units |
| Unit Price | 1.44 |
| Inventory Value | 4018.10 |
A.2 Last In/First Out (LIFO) Calculations
The LIFO costing method assumes that the last inventory items purchased are the first ones sold. This costing method determines the stock value and cost of goods sold based on the sale of the newest stock first. That is, the inventory that has been in stock the shortest amount of time is sold first. This method results in an ending inventory balance based on the costs associated with the oldest inventory. Second, this method requires that the system records historical costs for all years with stock remaining for that year.
The LIFO costing method values inventory using some unique processes that are important to point out:
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The LIFO method values inventory based on the activity that occurred on a year-to-date basis instead of a rolling (carry forward) inventory balance. To facilitate this type of processing, when the system applies this method for each period, the prior period's entries are reversed, making the new entries the current year-to-date values.
This reversal is done for all periods except for the last period of the year.
The reversals every period also keep the opening inventory constant until the end of the year. Thus, the opening inventory is always the same regardless of what transpired in the prior period, because the prior period's entries are reversed.
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The system stores the total purchase quantity, amount, and average price for each period of the year. The stored information allows the system to allocate the closing inventory, starting with the current period and allocating to prior periods.
The LIFO example presented later in this documentation further illustrates this process.
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Because the LIFO method's purpose is to reflect the inventory value accumulation or depletion at the end of the year, the entries that are logged at the end of each period need to be adjusted to remove the effect of any accumulation or depletion. This adjustment is called a "LIFO adjustment." You must do a LIFO adjustment for all periods except the last period of the year. The system records the LIFO adjustment against the income and balance sheet accounts. See Section A.2.2, "Accumulation/Depletion Credit or Debit" matrix for instructions on when to debit and credit the appropriate accounts.
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You might not always know the price of an item when you receive it. Because a quantity without a price can cause a large fluctuation in the average price, you can enter and use an override price for each period.
Later in this documentation the tables for May and December illustrate price overrides.
A.2.1 Formulas Used in LIFO Calculations
| Abbreviation | Definition |
|---|---|
| ABS | Absolute value of |
| Accum | Accumulation |
| COGS | Cost of good sold |
| CPUR | Current period average cost |
| DEPLT | Depletion |
| FPUR | First average cost (average allocated cost) |
| INVL | Inventory value |
| INVQ | Inventory quantity |
| PTD | Period to date |
| PURQ | Purchase quantity |
| PURV | Purchase value |
| QTY | Quantity |
| SALQ | Sales quantity |
| YTD | Year to date |
| Term | Equation |
|---|---|
| Opening inventory quantity | Sum of quantity accumulations of all existing layers |
| Opening inventory value | Sum of value accumulations of all existing layers |
| Period purchase price average | ((Sum of PURV) / (Sum of PURQ)) |
| Accumulation/ Depletion | YTD PURQ - YTD SALQ |
| Total closing INVQ | Opening INVQ + YTD PURQ - YTD SALQ |
| Closing INVQ allocations | Accumulations:
QTY = (accumulation - Jan PURQ) If QTY > 0, then QTY - (QTY - Feb PURQ) Depletions: QTY = (depletion - prior Year1) If QTY > 0, then QTY = (QTY - Prior Year2) |
| Closing inventory value | Opening INVL + total allocation value |
| Cost of goods sold | Opening INVL + total YTD PURV - closing inventory value |
| Material balance | Opening INVQ + total YTD PURQ - closing INVA - YTD SALQ |
| Average accumulation price | Total allocation value / total allocation quantity |
| Accumulation/depletion adjusted price | Average accumulation price - PTD average price |
| Accumulation/depletion amount | Accumulation/depletion price * ABS (accumulation or depletion) |
A.2.2 Accumulation/Depletion Credit or Debit
| Description | Result |
|---|---|
| Accumulation | Balance Sheet
Income Statement
|
| Depletion | Balance Sheet
Income Statement
|
The following example demonstrates the LIFO principle using the first five and the last months of a fiscal year. For simplicity, the example assumes that the company made no transactions from May through November.
The example reflects only the effect of the purchase price on the cost of inventory. It does not show the other factors, such as freight, exchange rate differences, loans, and borrows, that can affect the cost of the inventory.
The example presents three layers of accumulation prior to the current year (2017). The opening balance for the year is the sum of the accumulations for the prior layers.
Figure A-10 Three Layers of Accumulation (1 of 2)
Description of "Figure A-10 Three Layers of Accumulation (1 of 2)"
Figure A-11 Three Layers of Accumulation (2 of 2)
Description of "Figure A-11 Three Layers of Accumulation (2 of 2)"
During January, the company purchased a total of 1400 units for 2,800.00. They sold 900 units. The system uses the following formula to determine the closing inventory for a specified period:
Opening inventory (147,000) + purchases (1400) - sales (900) = closing inventory units (147,500)
The system calculates the accumulation/depletion from the beginning of the year with the following formula:
Closing inventory (147,500) - opening inventory (147,000) = accumulation/depletion (500)
The closing inventory quantity needs to be allocated to the correct purchase quantities and dates for the LIFO method. The system allocates the closing inventory as follows:
Figure A-12 January Total Closing Inventory Value
Description of "Figure A-12 January Total Closing Inventory Value"
Once properly allocated, the system multiplies the closing allocations by the respective purchase price and sums them to calculate the closing inventory value:
Sum (closing allocations * purchase price) = closing inventory value (170,800.00) + (500 * 2.00) = 171,800.00
Once the closing inventory value has been determined, the system calculates the COGS using the formula:
Opening inventory value (170,888.00) + purchases (2800.00) - closing inventory value (171,800.00) = COGS (1800.00)
The system calculates the average cost with the following formula:
Total purchase amount (2800.00) / total purchase quantity (1400) = average cost (2.00)
The system uses the following formula to calculate the LIFO adjustment:
Average price of the accumulation/depletion (1000.00 / 500) - current period's average price (2800.00 / 1400) = LIFO adjustment (0.00)
Therefore, the LIFO adjustment is the accumulation/depletion (500) * the accumulation/depletion cost (0.00) = 0.00
In February, the January period ending entries are reversed before you make the February entries.
Figure A-13 February Total Closing Inventory Value (1 of 2)
Description of "Figure A-13 February Total Closing Inventory Value (1 of 2)"
Figure A-14 February Total Closing Inventory Value (2 of 2)
Description of "Figure A-14 February Total Closing Inventory Value (2 of 2)"
The system uses the same formulas and makes the calculations based on the February transactions.
During February, the company purchased a total of 1500 units for 3150.00. They sold 500 units. The system uses the following formula to determine the closing inventory:
Opening inventory (147,000) + purchases (1400 + 1500) - sales (900 + 500) = closing inventory (148,500)
The accumulation/depletion from the beginning of the year is:
Closing inventory (148,500) - opening inventory (147,000) = 1500
The system allocates the closing inventory as follows:
Figure A-15 February Closing Inventory Allocation
Description of "Figure A-15 February Closing Inventory Allocation"
The system calculates the February COGS:
Opening inventory value (170,800.00) + purchases (2800.00 +3150.00) - closing inventory value (173,810.00) = COGS (2940.00)
The system calculates the February average cost:
Total purchase amount (3150.00) / purchase quantity (1500) = average cost (2.10)
The system calculates the LIFO adjustment:
Average cost of the accumulation/depletion (2800.00 + 210.00 / 1500) - current period's average cost (2.10) = (0.09)
Accumulation/Depletion (1500) * accumulation/depletion average cost (0.09) = LIFO accumulation/depletion adjustment (140.00)
See the matrix indicating how to credit or debit accumulation/depletion to determine how to make the income statement and balance sheet entries for the LIFO adjustment.
In March, the February period ending entries are reversed before you make the March entries.
Figure A-16 March Total Closing Inventory Value (1 of 2)
Description of "Figure A-16 March Total Closing Inventory Value (1 of 2)"
Figure A-17 March Total Closing Inventory Value (2 of 2)
Description of "Figure A-17 March Total Closing Inventory Value (2 of 2)"
The system uses the same formulas and makes the calculations based on the February transactions.
During March, the company purchased a total of 700 units for 925.00. They sold 2500 units. The system uses the following formula to determine the closing inventory:
Opening inventory (147,000) + purchases (1400 + 1500 + 700) - sales (900 + 500 + 2500) = closing inventory (146,700)
The accumulation/depletion from the beginning of the year is:
Closing inventory (146,700) - opening inventory (147,000) = <300>
The system allocates the closing inventory as follows:
Figure A-18 March Closing Inventory Allocation
Description of "Figure A-18 March Closing Inventory Allocation"
The system calculates the March COGS:
Opening inventory value (170,800.00) + purchases (2800.00 +3150.00 + 925.00) - closing inventory value (170,455.00) = COGS (7220.00)
The system calculates the March average cost:
Total purchase amount (<3450.00>) / total purchase quantity (<300>) = average cost (1.15)
The system calculates the LIFO adjustment:
Average cost of the accumulation/depletion(345 / 300 = 1.15) - current period's average cost (925 / 700 = 1.32) = accumulation/depletion cost (<.17>)
Accumulation/depletion (300) * accumulation/depletion cost (<0.17>) = LIFO accumulation/depletion adjustment (<51.43>)
See the matrix indicating how to credit or debit accumulation/depletion to determine how to make the income statement and balance sheet entries for the LIFO adjustment.
The depletion in March reduced the inventory of a prior layer. April's opening balance will be the same as all of the other months due to the fact that the prior period entries are reversed.
The remaining months follow the same calculations. In December, the last period in the year, no LIFO adjustment entries are made to the accounts.
Two different tables are presented for December:
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The first December example has a closing inventory as an accumulation. This creates a LIFO layer for 2017.
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The second December example has a depletion. The depletion is removed from the prior (2016) layer's quantity. No new layer is created.
Figure A-19 December Closing Inventory as Accumulation (1 of 6)
Description of "Figure A-19 December Closing Inventory as Accumulation (1 of 6)"
Figure A-20 December Closing Inventory as Accumulation (2 of 6)
Description of "Figure A-20 December Closing Inventory as Accumulation (2 of 6)"
Figure A-21 December Closing Inventory as Accumulation (3 of 6)
Description of "Figure A-21 December Closing Inventory as Accumulation (3 of 6)"
Figure A-22 December Closing Inventory as Accumulation (4 of 6)
Description of "Figure A-22 December Closing Inventory as Accumulation (4 of 6)"
Figure A-23 December Closing Inventory as Accumulation (5 of 6)
Description of "Figure A-23 December Closing Inventory as Accumulation (5 of 6)"
Figure A-24 December Closing Inventory as Accumulation (6 of 6)
Description of "Figure A-24 December Closing Inventory as Accumulation (6 of 6)"
Figure A-25 December Closing Inventory as Depletion (1 of 2)
Description of "Figure A-25 December Closing Inventory as Depletion (1 of 2)"
Figure A-26 December Closing Inventory as Depletion (2 of 2)
Description of "Figure A-26 December Closing Inventory as Depletion (2 of 2)"
A.2.3 Weighted Average Cost Calculations
The Weighted Average Cost method calculates the inventory value based on a cost that is a weighted average of the purchases for a given period. The given period can also be a year-to-date range, which includes all purchases from the beginning of the year.
The following example only reflects the effect of the purchase price on the cost of inventory. It does not show the other factors, such as freight, exchange rate differences, loans, and borrows, that can affect the cost of the inventory.
Figure A-27 Weighted Average Cost Calculations
Description of "Figure A-27 Weighted Average Cost Calculations"
The opening inventory quantity, cost, and value are the closing figures from December of the previous year. In the month of January, the company purchased a total of 1400 units for 2800.00. The company sold 900 units.
The system uses the following formula to calculate the closing inventory for January:
Opening inventory (500) + purchases (1400) - sales (900) = total closing inventory (1,000)
The system calculates the closing inventory value with the following formula:
Closing inventory value = sum (closing inventory units * weighted average cost)
The system calculates the weighted average cost with the following formula:
Weighted average cost = ((opening inventory value + total purchases value) / (opening inventory units + total purchase units))
((600.00 + 2800.00) / (500 + 1400)) = 1.79 (weighted average cost)
Because the weighted average cost for January is 1.79, the closing inventory value is:
1000 * 1.79 = 1789.47
Once the closing inventory value has been determined, then the system calculates the COGS with the following formula:
Opening inventory value (600.00) + purchases (2800.00) - closing inventory value (1789.47) = COGS (1610.53)
This closing inventory value, along with the weighted average price of 1.79, will be the opening values for the next period, February.
The system performs the same calculations for the ensuing months of the fiscal year.
The month of December follows the same principles and the closing inventory becomes the opening inventory for the next year.