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Inventory: Inventory Value Overview - Study Sheet

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Description: Use this Smartacus Study Sheet to understand how to find the value of inventory and cost-of-goods-sold. Explore definitions and methods (including Average Cost Method, LIFO, and FIFO). It also prints for easy reference.
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Contents

  1. Accounting Terms
  2. Inventory Valuation
  3. Average Cost Method
  4. FIFO (First In, First Out) Method
  5. LIFO (Last In, First Out) Method
  6. Inventory Rates and Ratios
  7. Inventory Turnover Rate At Cost
  8. Inventory Turnover Rate At Retail
  9. Inventory Turnover Ratio
  10. Accounting Homework Help: Related Links

Accounting Terms

  • Cost of Goods Sold is a measure of the direct cost involved in acquiring or producing goods that are, in turn, sold. The methods of measuring cost of goods sold are explained below, but a company's chosen method must be consistent with their method of measuring inventory value.
  • Inventory represents finished and unfinished goods which have not yet been sold by a company.
  • Inventory Valuation is a measure of the value of a comapny's unsold inventory. The methods of measuring inventory value are explained below, but a company's chosen method must be consistent with their method of measuring cost of goods sold.

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Inventory Valuation

The value of a company's inventory can be calculated using one of the following methods:

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Average Cost Method

  • Assumes an inventory of non-unique goods (that is, every one is similar to every other one)
  • Not generally recommended where prices are volatile
  • Tends to even out price fluctuations over time
  • Uses the average unit cost to calculate the value of current inventory:

    • Average Unit Cost = (Total Unit Cost)/(Total Quantity of Units)

    Inventory Value = (Average Unit Cost) x (Units of Current Inventory)

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FIFO (First In, First Out) Method

  • Assumes an inventory of non-unique goods (that is, every one is similar to every other one)
  • Generally preferred inventory valuation method
  • Assumes inventory is sold in the order that it is stocked, with the oldest goods sold first and the newest goods sold last
  • Uses the unit cost per batch of acquired/produced goods, and counts the inventory backwards from the newest batch:

    • Unit Cost per batch = (Cost/Quantity) for each batch

    Inventory Value = (Unit Cost x Quantity) for each batch

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LIFO (Last In, First Out) Method

  • Assumes an inventory of non-unique goods (that is, every one is similar to every other one)
  • Is highly regulated (or, in some cases, illegal) as a method for measuring inventory value
  • Assumes newest inventory is sold first, with the oldest goods sold last
  • Uses the unit cost per batch of acquired/produced goods, and counts the inventory forwards from the oldest batch:

    • Unit Cost per batch = (Cost/Quantity) for each batch

    Inventory Value = (Unit Cost x Quantity) for each batch

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Inventory Rates and Ratios

These rates and ratios can be useful in analyzing a company's inventory levels:

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Inventory Turnover Rate At Cost

  • Measures inventory turnover over a period of time, as defined by the starting and ending dates
  • Given the cost of goods sold, starting inventory value at cost, and the ending inventory value at cost (all from the balance sheet):

    Average Inventory Value at Cost = (Starting Inventory + Ending Inventory)/2

    Rate = (Cost of Goods Sold)/(Average Inventory Value at Cost)

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Inventory Turnover Rate At Retail

  • Measures inventory turnover over a period of time, as defined by the starting and ending dates
  • Given the cost of goods sold, starting inventory value at cost, and the ending inventory value at cost:

    Average Inventory Value at Retail = (Starting Inventory + Ending Inventory)/2

    Rate = (Net Sales)/(Average Inventory Value at Retail)

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Inventory Turnover Ratio

  • Demonstrates the company's ability to convert inventory into cash, and is one predictor of a company's liquidity
  • Generally a higher ratio is better, but values should be compared with industry averages for the best interpretation
  • Given a company's sales (from the income statement) and inventory value (from the balance sheet):

    • Inventory Turnover Ratio = (Sales)/(Inventory Value)

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Accounting Homework Help: Related Links

Learn more about inventory topics and methods.

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