Accounting – 4.5 Valuation of inventory | e-Consult

FIFO (First-In, First-Out):

1. Assume the opening inventory was purchased at the beginning of the period.
2. The £35,000 in purchases are assumed to be sold from the opening inventory first.
3. This leaves £35,000 - £12,000 = £23,000 of purchases to be sold.
4. The remaining £18,000 of closing inventory represents the purchases made last.
5. Therefore, COGS = £12,000 + £23,000 = £35,000.

Weighted Average Method:

1. Calculate the total cost of goods available for sale: Opening Inventory + Purchases = £12,000 + £35,000 = £47,000
2. Calculate the number of units available for sale (assuming each unit has the same cost): We need to know the number of units. Let's assume each unit costs £10. Then, the total number of units available is £47,000 / £10 = 4700 units.
3. Calculate the weighted average cost per unit: £47,000 / 4700 units = £10 per unit.
4. COGS = Weighted Average Cost per Unit * Number of Units Sold. We don't know the number of units sold, so we can't calculate the exact COGS. However, if we assume all the inventory was sold, COGS would be £47,000. If we assume the closing inventory represents the unsold units, we need to calculate how many units are in the closing inventory. Since the closing inventory is £18,000 and each unit costs £10, there are 1800 units in the closing inventory. Therefore, the number of units sold is 4700 - 1800 = 2900 units. COGS = £10 * 2900 = £29,000.

Generally Preferred Method:

The FIFO method is generally preferred because it more accurately reflects the flow of inventory. It assumes that the oldest inventory is sold first, which is usually the case. This provides a more realistic view of the company's current inventory value on the balance sheet. The Weighted Average method can distort the true cost of goods sold, especially if there are significant fluctuations in purchase prices.