Recalculating the average cost, after these purchases, is accomplished by dividing total cost of goods available for sale (which totalled $1536 at that point) by the number of units held, which was 110 units, for an average cost of $13.96 per unit. The company bought 30 more units for $14 per unit and 45 more units for $15 per unit on 15th September and 23rd September respectively. Once those units were sold, there remained 35 more units of the inventory, which still had a $12.60 average cost. This brings the total cost of these units in the first sale to $819 (65 x $12.60). ![]() At this juncture, an average cost will be calculated using the following formula:Īverage unit cost = Cost of Goods Available for Sale / Units Available for Sale For In Style, the first sale of 65 units is assumed to be the units from the beginning inventory of 40 units, which had cost $12 per unit, and the purchase of 60 units on 4th September at a cost of $13 per unit. Weighted-average cost allocation requires computation of the average cost of all units in goods available for sale at the time the sale is made for perpetual inventory calculations. Ending inventory was made up of 25 units at $14 each and 35 units at $12 each, for a total LIFO perpetual ending inventory value of $770. At the time of the second sale of 50 units, the LIFO assumption directs the company to cost out the 45 units from the latest purchased units, which had cost $15 per unit and the remaining 5 units from the earlier purchase on 15th September at $14 per unit, for a total cost on the second sale of $745. Once those units were sold, there remained 35 more units of beginning inventory. For In Style Fashion, using perpetual inventory system, the first sale of 65 units is assumed to be the 60 units from the 4th September purchase, which had cost $13 per unit and 5 units from the beginning inventory, which had cost $12 per unit, bringing the total cost of these units in the first sale to $840. ![]() The last-in, first-out method (LIFO) of cost allocation assumes that the last units purchased are the first units sold. Ending inventory was made up of 15 units at $14 each, and 45 units at $15 each, for a total FIFO perpetual ending inventory value of $885. At the time of the second sale of 50 units, the FIFO assumption directs the company to cost out the last 35 units of the 4th September purchased inventory, plus 15 of the units that had been purchased for $14 on 15th September. Once those units were sold, there remained 35 more units of the 4th September purchased inventory. For In Style Fashion, using the perpetual inventory system, the first sale of 65 units is assumed to be the 40 units from the beginning inventory, which had cost $12 per unit, and the remaining 25 units from the purchase made on 4th September, which had cost $13 per unit, bringing the total cost of these units to $805. The FIFO method of cost allocation assumes that the earliest units purchased are also the first units sold. Assume that In Style Fashion has the following inventory activity for September: ![]() To illustrate each method, the following example from In Style Fashion will be used. In this section, you will be provided with a basic demonstration of each of the three allocation methods, and then further delineation of the application and nuances of the two costing system – perpetual and periodic – introduced in the previous section. ![]() Use of a cost allocation strategy eliminates the need for often cost-prohibitive individual tracking of costs of each specific inventory item, for which purchase prices may vary greatly. Note that a company’s cost allocation process represents management’s chosen method for expensing product costs, based strictly on estimates of the flow of inventory costs, which is unrelated to the actual flow of the physical inventory. Nevertheless, LIFO is still used globally by other countries such as Japan and US. In Australia, AASB 102 does not allow the use of the second method, LIFO. All three methods are techniques that allow management to distribute the costs of inventory in a logical and consistent manner, to facilitate matching of costs to offset the related revenue item that is recognised during the period, in accordance with expense recognition and matching concepts. Inventory costing is accomplished by one of three specific costing methods: (1) first-in, first-out (FIFO), (2) last-in, first-out (LIFO), and (3) weighted-average (WA) cost methods.
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