How to Calculate Inventory

This article will show how to calculate inventory through costing methods.

Instructions

Difficulty: Moderately Easy

Things You’ll Need:

• Pencil
• Calculator
• Paper
• Financial Statements

1. There are two main systems of Inventory used:
   
   Periodic System & Perpetual System
   
   We will be using Periodic because it is most commmon with computerized accounting software these days.
2. www.accountingsoftwareconsultants.net You must know what counts in inventory.
   
   (1) Goods on Consignment
   (2) Goods in Transit
   - FOB Shipping Point = Buyers Liability; Buyer OWNS goods as soon as they are shipped.
   - FOB Destination = Sellers Liability; Seller owns goods until they reach the buyer or destination.
3. There are 4 main Inventory costing methods. These are:
   
   (1)FIFO - First In/First Out... meaning that the first items in were the first items to be sold out.
   (2)LIFO- Last In/First Out... meaning that the last items in were the first items out. Example: Grocery Stores that rotate stock.
   (3)Weighted Average
   (4)Specific Identification - Example: Car Dealerships with different cars on lot.
4. There are also two methods of estimating ending inventory. These are:
   
   (1)Gross Profit Method
   (2)Retail Method
5. FIFO (must be calculated from bottom of chart up) Let's use this chart below.
   
   Units Unit Price Total
   Beginning Inventory 40 $62.00 $2480.00
   1st Purchase 60 65.00 3900.00
   2nd Purchase 80 67.00 5360.00
   3rd Purchase 20 68.00 1360.00
   Total 200 13,100.00
6. Can you see how we calculated Total?? Multiplied Units by Unit Price for Total. 40 * 62.00 = 2480.00. Now, let's say we had 50 units left over at the end of the period.
   
   Using FIFO we calculate Ending Inventory from bottom-up. So, we must add up units unti we reach 50 because the rest of the units were already sold. We only have 50 left over. See how that works??
   
   So, first we take 20 units x 68.00 = 1360.00
   Next, we take the remaining 30 units x 67.00 = 1710.00
   So, total we have 50 units with ending Inventory at: 1360 + 1710 = 3070.00. Now we will calculate Cost of Goods Sold.
   
   COGS= Cost of Goods Available for Sale(COGAS) - Ending Inventory
   COGS= 13,100.00 because that is total COGAS - 3070.00 = 10,030.00 for COGS. It only costed us 10,030.00 to make, produce, and sell these products.
7. LIFO is very similiar to FIFO except for we calculate from top-down. LIFO is not as accurate as FIFO and results will be different. So, let's use the chart above. Remember there are 50 units left. So, 40 * 62.00 = 2480.00 and 10 * 65.00 = 650.00. At 50 units the ending inventory is 2480.00 + 650.00 = 3130.00. See how different the amounts are?? COGS is calculate the same way as above.
8. For Specific Identification you must have "specific" amounts of information on the products. Such as how many units were sold in a specific period of time. Example: You had 90 units and out of those 90 units 30 were from Jan.(1st purchase), 20 were from Feb.(2nd purchase), 10 were from Mar.(3rd), and 30 from Apr.(4th) and then calculate using unit prices like above to get Ending Inventory.
9. Weighted Average is much easier than the others. Weighted Avg. is avg cost per unit. Formula is this:
   
   COGAS in dollars divided by COGAS in units = Avg cost per unit.
   
   So, back to the chart above. COGAS in dollars is 13,100.00 / COGAS in units 200 = $65.50 avg cost per unit. That should be right because the value should be between 62.00 and 68.00.
   
   Now multiply Units on hand by Unit Cost to figure Ending Inventory. So, 50 Units on hand * $65.50 Cost = $3,275.00 in EI. COGS is calculated the same.
10. Gross Profit Dashboard. http://www.dashboardinsight.com Estimating Ending Inventory methods:
    (1) Gross Profit Method. Let's assume:
    
    Beginning Inventory $60,000.00
    Net Purchases $380,000.00
    Net Sales $650,000.00
    Normal Gross Profit as percentage of sales 45%
    
    Beg. Inv. + Purchases = COGAS
    60,000.00 + 380,000.00 = 440,000.00
    
    Cost % = 100% - 45%
    Cost % = 55%
    
    So, estimated COGS is 650,000.00 * 55% = 357,500.00 OR Net Sales x Cost %.
    
    Now, Ending Inventory = COGAS - COGS. So, 440,000.00 - 357,500.00 = 82,500.00. That is the Gross Profit Method of estimating ending inventory, please see warnings regarding this concept.
11. Retail Method Chart used realistically. http://www.retailowner.com Finally, the Retail Method.
    
    Cost Retail
    Beginning Inv. $50,000 $80,000
    Net Purchases $220,000 $352,000
    Net Sales $310,000
    
    So, Beg. Inv. + Net Purchases at Cost and Retail= COGAS
    At Cost - 50,000 + 220,000 = 270,000 COGAS
    At Retail- 80,000 + 352,000 = 432,000 COGAS
    
    COGAS @ Retail - Sales = End Inv @ Retail
    432,000 - 310,000 = 122,000
    
    COGAS @ Cost / COGAS @ Retail = Cost %
    270,000 / 432,000 = 62.5 %
    
    End Inv at Cost = End Inv at Retail x Cost %
    76,250.00 = 122,000.00 x 62.5%
    
    That is the Retail Method! Probably the most confusing.

Tips & Warnings

• Once an Inventory costing method is chosen for your business it has to be implemented until you go out of business. Cannot be changed for tax advantages.
• However, you can send in a request for change to the IRS. See warnings below.
• Please see my COST OF GOODS SOLD article for more info on that subject!!
• FIFO and LIFO must be implemented. Much harder to change for tax advantages!!
• Weighted Avg. and Specific Identification can be changed through request form to IRS. Not guaranteed, but much easier to change to LIFO or FIFO after this is implemented for a while.
• Gross Profit Method calculation is appropriate only if the firm's normal gross profit as a percentage of sales has been relatively stable over time!!!