6RQ - Horngren'S Financial And Managerial Accounting

Question

Under a perpetual inventory system, what are the four inventory costing methods, and how does each method determine ending merchandise inventory and cost of goods sold?

Step-by-Step Solution

Answer

Inventory costing is the process of evaluating the cost of ending inventory by matching the cost of procurement at different points of time with the issued inventory at different points of time.

Inventory costing methods under a perpetual system

Inventory costing is the process of evaluating the cost of ending inventory by matching the cost of procurement at different points of time with the issued inventory at different points of time.

This is done by using four methods –

1) Specific identification method

2) First in First out (FIFO)

3) Last in First out (LIFO)

4) Weighted Average Method

Specific identification method

Under this method, the specific cost is used for determining the ending inventory cost and cost of goods sold. This method is useful where each inventory has a specific feature and cost like jewelry, automobiles, real estate.

First in First out (FIFO)

Under this method, the cost of sold units is calculated based on the inventory first introduced into the stock. Thus the cost of goods sold would always be on the historical cost. The cost of ending inventory under this method is valued based on the current cost.  

Last in First out (LIFO)

In this inventory valuation method, the issued inventories are valued based on the latest cost price and the ending inventory is valued on the basis of the oldest inventory introduced into the stock.

 

Weighted average method

In the perpetual system, the weighted average cost is computed after each purchase and that average cost price is the cost for issued and ending inventory per unit until the next purchase is made.