Inventory Costing Methods
Inventory costing: Periodic and Perpetual Inventory System
In other to keep records of inventory the cost of inventory is to be determined. The inventory cost includes the purchase price of inventory, wages, transportation, and other cost incurred while bringing the inventory to the business place. There are two approaches to inventory costing they are perpetual and periodic inventory system.
Periodic Inventory System
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. This is the traditional costing system. 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 this 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.
Perpetual inventory system
The perpetual inventory system is an improved version of the periodic inventory system. Also, it is called modern inventory system. Under perpetual inventory system, computer software can be used to determine the cost of goods sold and cost of ending inventory. This system determines each day’s cost of goods sold and cost of ending inventory. In this system, each day’s transactions of inventory are recorded which can be watched at the interval of time with physical counting of inventory that is stored in the warehouse. As a computer system is used this system is costly as compared to the periodic inventory system.
Methods of Inventory Costing
There are four methods of inventory costing after each of the above mention inventory costing system. They are:
- First-In-First-Out (FIFO) Method
- Last-In-First-Out (LIFO) Method
- Specific Identification Method
- Weighted Average Cost (WAC) Method
First-In-First-Out (FIFO) Method
According to this method, the inventory which is purchased at first is sold out or used at first. This method is applicable to the company’s that sales flexible goods. According to this method, the closing stock includes the inventories which are recently purchased.
Last-In-First-Out (LIFO) Method
According to this method, the recently purchased goods are sold or used at first. The beginning and earlier goods purchased are ending inventory. This method is applicable to the organization which durable goods. The advantages of this method over the FIFO method is that it helps to save tax because the cost of goods sold under this method for the same information is higher than that in the FIFO method.
Weighted Average Cost (WAC) of Capital Method
According to this method the average cost for the good available for sale is calculated at first. The same WAC is used to calculate cost of goods sold and cost of ending inventory. This method provides average tax in between FIFO and LIFO method.
WAC = Cost of goods available for sale/ Units of goods available for sale
Cost of Goods Sold = WAC * Units sold
Cost of Ending Inventory = WAC * Units on Hand
Specific Identification Method
Under this method, the management can easily identify which inventory is purchased when, and when that inventory is sold. This method is applicable to the goods which can be tressed out by the specific identification method. Such as TAG number, CL number, ISBN (International Standard of Book Numbers), etc. Under this method, the management can manipulate data and accordingly to show profit and tax.