Inventory Techniques

One of the easiest parts of accounting is keeping track of inventory using different inventory techniques

. There are four basic types of methods used and they are, Last-In-First-Out (LIFO), First-In-First-Out (FIFO), weighted average, and specific identification. Many students find this part of accounting confusing, but once you learn and fully understand it, it is hard to get it wrong.

First I'll explain to you Last-In-First-Out also known as LIFO. When you use LIFO the last inventory brought into the store is the first to be sold. The best way to explain this is to show by example. Lets say we have a corporation, Posters Inc, which sells posters and has a beginning inventory is $40, because they have 5 posters already, which were purchased at $8 each. Posters Inc buys 6 more posters at a cost of $9 each, totaling $54. Now the current inventory has increased to $94. Posters Inc sold 4 posters, and because we are using the LIFO method to track our inventory those 4 posters that were sold we account for as the last 4 posters, which were purchases at $9. We now subtract $36 (4 posters at $9 each) from our current inventory of $94 to get an ending inventory of $58.

Next we'll work in First-In-First-Out better known as FIFO. As LIFO sounds pretty self explanatory, so does FIFO. The first items to be brought into the store are the first merchandise to be sold. We will continue with the same example of Poster Inc that has a beginning inventory of 5 posters at $8 totaling $40. Again Posters Inc is going to add 6 posters to their inventory at $9, bringing their inventory to $94. Posters Inc again has sold 4 posters, but this time instead of subtracting $36 from our inventory we are going to subtract $32. This is because we are using the FIFO method, which means we subtract 4 posters at the price of $8 each because that it what was in inventory first. This then results in an ending inventory of $62, because we subtract $32 from $94.

Next we have weighted average. Weighted average gets a little more complicated than LIFO or FIFO do, but once you understand it, it becomes very clear. Again we will continue using the same example of Poster Inc, with the beginning inventory of $40 (5 posters purchased at $8 each). Once more we will say that Posters Inc brings in 6 more posters at $9 increasing their inventory to $94. Now 4 posters were sold. To get the weighted average of how much inventory was removed we divide the amount of money in inventory by the number of objects (in this case posters) in inventory. This will give us the cost per unit in our inventory. So because inventory was at $94 with 11 posters in inventory we do 94 divided by 11 (94/11) which comes out to $8.50. Now we take 11 posters out of inventory at $8.50 each, which is $34 taken away from $94 leaving us with an ending inventory of $60. A common error students tend to make while using weighted average is to take the average of the costs (taking the average of $8 and $9) instead of finding the average cost per unit. In this example you will find even if you make this mistake you will still come out with the same ending inventory but that is not always the case. So make sure to double-check your work so you do not end up making this error.

The simplest method to understand is specific identification. This is because when accounting for inventory you simply take the exact price of which product was sold. For example, Posters Inc has a beginning inventory of $40 (5 posters at $8), and then had added another 6 posters for $9 each, bringing inventory to 11 posters at $94. Now lets say 4 posters were sold, but specifically, 3 posters that were bought at $8 were sold, and 1 that was purchased at $9. Now we subtract $33 (3x8 plus the $9) from inventory, leaving us with an ending inventory of $61. Although this is a very easy method to understand, it is more difficult to use in a store because that means you would need to keep track of how much you bought each individual product at.

The ending inventory's of each method comes out different, but they are not significantly different from each other. This is why when using this in the real world you might find that one company uses one method, while another company will use a different method. One method is not better than the other because the difference in ending inventory is going to be immaterial or insignificant. Now you can successfully use four different inventory techniques.

Inventory Techniques

By: Katie Wallman

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