Periodic Inventory - FIFO, LIFO, and Average Cost - Online Tutor, Practice Problems & Exam Prep

In a periodic inventory system, cost flow assumptions like FIFO (First-In, First-Out), LIFO (Last-In, First-Out), and average cost are essential for tracking cost of goods sold (COGS) and inventory. FIFO sells the oldest units first, impacting COGS with older prices, while LIFO sells the newest units first, reflecting newer prices. Average cost calculates COGS based on the total cost divided by the number of units. The physical flow of goods does not need to match these costing methods, allowing flexibility in inventory management. Ending inventory is determined by counting remaining units after sales.

Periodic Inventory:FIFO, LIFO, and Average Cost

Alright now let's talk about how to use FIFO, LIFO, and average costing in a periodic inventory system. So when we sell large amounts of identical units, we can use different cost flow assumptions to track the cost of goods sold and inventory, okay? So remember, we're in a periodic system, so we're not going to be making cost of goods sold entries all the time, right? We don't make it after every sale like in a perpetual system, okay? We're only going to deal with the cost of goods sold at the end of the period. But which items did we sell, right? That's the whole trick here with FIFO, LIFO, and the average cost. Remember, we're talking about selling identical units here, right? So this is different, you know cans of soda, right? If you have all these different cans of soda, you can't tell one unit from the other, so we use cost flow assumptions to see which units we sold out of our inventory, okay?

So the first one is our first in, first out; this is what we call FIFO, right? First in, first out is FIFO, and this means that the oldest unit is sold first. Okay? The oldest unit is sold first, right? The first one that came into our inventory is the first one that goes out of our inventory, right? So the oldest unit is sold first, and that means that the cost of goods sold is going to be what you paid for older units, right? The oldest units that you have are the ones that are going to be put into the cost of goods sold. Compare that to, excuse me, last in, first out, that's LIFO, right? Last in, first out, so this means that the newest unit is sold first, right? So what's going to happen is our cost of goods sold is going to represent what we paid for the newer units, right? So the whole thing that makes this tricky is that every time we're purchasing new inventory, we're purchasing it at a different price in these problems, right? In these problems, it's not like, oh, you buy all your inventory at $2 a unit forever, right? Well then, we wouldn't need all these costing methods if it was just always the same price. Here, it's a way for us to deal with these changing prices, okay?

And then the last one here, average cost; well, we're just going to take an average. Okay? We're going to take an average cost that we've taken for all our units over time, and then that's what's going to go to the cost of goods sold would be that average of what we paid. So here's how we would find our average cost. We would take the total cost of everything we paid and divide it by how many units we bought, right? This will give us a cost per unit, okay? And that's what we want is a cost per unit, so you do your total cost divided by quantity. I want to make a really important note, okay? The cost flow assumption, whether we're using FIFO, LIFO, average cost, it does not have to be consistent with the physical flow of goods. Okay? Just because we're in LIFO, that doesn't mean we have to actually take the newest one of these cans and sell this can to our customer, right? It doesn't matter which can, remember, they're all identical, so this is just to deal with the cost of the inventory, not the actual physical flow of the goods, okay? So we can still even in a LIFO system, you might still want to sell off the oldest inventory because it has the nearest expiration date, okay? But there would be different reasons why you might want to use FIFO, LIFO, average cost; we'll talk about that a little more, but that's the big picture here is that the physical flow, right? Which can we're actually taking out of inventory to sell to the customer, it doesn't have to match up with this costing method we choose, okay? So remember that in a periodic system, an inventory count, we're physically going to count what's left. We're going to go into our warehouse, and we're going to say okay, we have this many cans of this stuff, we have this much of this stuff and we're going to count what's left and it's going to reveal the quantity in the ending inventory, okay? It's going to tell us how many, in this case, you know, for reselling cans of soda or something, it'll tell us how many cans of soda we have left in our inventory. Okay? So, let's go ahead and check this out. We're going to have to give you this ending inventory number. Okay? So, let's go ahead and check this out. We're going to use these formulas like we've been used to. We've had this base formula, this one. We've seen something like this before, right? We're going to have our beginning inventory and then we're going to purchase stuff throughout the period and then what decreases our inventory is when we make sales, right? And that goes to cost of goods sold and leaves us with ending inventory. Okay? We're adding one new little idea here in this top box and it's the idea of goods available for sale, and this is just the beginning inventory plus the purchases, okay? So if we think of what we had on hand at the beginning of the period and then everything that we bought during the period, well that's everything that we have available to sell to customers, right? And those goods available for sale, right? What we started with plus the purchases, we're either going to sell it to a customer so it'll go to cost of goods sold, or we're not going to sell it to a customer and it's still going to be an inventory, in the ending inventory, okay? So that's a good note there is that those goods available for sale, right? That's either going to end up in cost of goods sold or not in cost of goods sold and stay in inventory. Cool? So let's go ahead and see this example right here. Actually, let's pause here, and then we'll do the example in the next video. Alright? Let's take let's take a quick break.

Periodic Inventory FIFO Method

Alright. Let's try this example. So a company had the following inventory data for the month of July in its periodic inventory system. So there we go, we have the inventory and then the purchases, right? Notice that in a periodic system, we're not going to be updating the inventory every time we make a sale, right? We deal with how much cost of goods sold we had at the end of the period. So the month-end physical count noted that there were 800 units on hand, right? So this is going to be the goal of pretty much all the times when you're dealing with FIFO, LIFO, and average cost, it's going to be either to calculate COGS or to calculate the ending inventory based on the information given to you, okay? So we have to find out what COGS and ending inventory is going to be and let's do this one at a time. Let's start with FIFO, then we'll do LIFO and then we'll do average cost. So let's start here with FIFO. The first thing we want to know is how much did we sell, right? Cost of goods sold, how many units did we sell? So the first thing we want to know is how many total units were there available for sale, right? We started with an inventory balance of 1000 units, and then we purchased 500 units and 600 units, so we could say that the total units that were available for sale were 2,100 units, right? 1000 plus 500 plus 600 gives us 2,100 total units, and they tell us that 800 of those units were left at the end of the period, right? So that means if there were 2,100 total that were available for sale, we either sold them or we didn't sell them, right? And the ones we didn't sell are the 800 that are left over, right? So if we take 2,100, the total available for sale, minus the 800 that are left over at the end of the period, we know that 1300 units were sold, right? We sold 1300 units. So that's the first step to find out how many units did we actually sell and that is by taking what's left over and the total right? In this case, we're in a FIFO system, right? So the FIFO system means that the first unit we bought is the first unit we're going to sell. So in this case, our beginning balance is the first thing we're going to sell. So we're going to sell all 1000 of that beginning balance, right? We're going to sell 1300 units but we're going to eliminate that beginning balance first. So the 1000 units in beginning balance times the $20 per unit, well, that's going to be $20,000 right? $20,000 for those first 1000 units, but we sold 1300 units, right? Not just 1000. So where are those next 300 units going to come from? Well, from the first in first out, right? We want to look at the oldest units. So in this case, we already sold the beginning balance, right? Don't cross these out, I'm going to uncross them because we're going to do this a bunch of times. So we sold those already, so we need to sell 300 more and that's going to come out of this purchase, right? Because that was the first ones in. We want to sell the oldest units first, so we're going to sell 300 of those, right? We don't sell the full 500, we only sold 1300 units, the first 1000 was the beginning balance and then 300 came out of this purchase. So that's a little bit of the trick there, right? We didn't sell that entire purchase, we only sold 300 from that purchase. So 300 times the price of that purchase which was $22.40. Well, I can't do that one in my head. Let's go ahead and type this in. 22.40 times 300, that comes out to 6,720. Okay? So that means this is our cost of goods sold, right? We figured out that we sold 1300 units and now we found the cost of those units. Okay? We picked out which units we sold and this is going to be the cost. $26,720. Alright? That's our cost of goods sold in the FIFO method. Okay? So now let's go ahead and see what's left in ending inventory, right? Ending inventory is going to be everything that we didn't sell. Sell, so we sold that inventory balance at the beginning, right? We sold the beginning balance and we sold 300 units from the purchase on July 11th. So we have 800 units here that we're dealing with here, right? They told us that in the problem there were 800 units on hand at the end of the month, so which ones are on hand? It's going to be the last units we bought, right? Because we sold all of the first units, so all that's left are the last units, so we definitely know that the 600 is still on hand, the 600 from July 30th, and those 600 were at a price of $23.30 So let's go ahead and figure out what those are worth. 600 times 23.3, $13,980 for those 600 units, but there are 800 total units, right? So those last 200, well, that's the 200 that we didn't sell from this shipment on July 11th, right? So it's going to be 200 units from the July 11th shipment times $22.40. So let's see how much that comes out to. 200 times 22.4, $4,480. Okay? So there we go. Now we know the value of our ending inventory gives us $18,460. Okay? So there we go. Our ending inventory is going to have that balance and our cost of goods sold would be the other number we calculated there. Cool? So now let's see how it's different from a LIFO perspective and from an average cost perspective. Alright, let's pause here and then we'll continue with the LIFO example.

Periodic Inventory LIFO Method

Alright. Let's continue here with the LIFO example. So I'm going to erase all this stuff and we'll continue, but a lot of our information is going to stay the same. So we're still going to deal with those 2,100 total units available for sale, right? We had the 1,000 we started with and then we made 2 purchases for more units, right? We're thinking in a physical amount of units there to think about how many physical units we sold and how many physical units are left over, right? So they did tell us that 800 are left over, they're generally going to have to do that in any periodic inventory problem. Okay? So again, it's going to be the same situation where we have 2,100 units available for sale minus the 800 that are left over. Again, we sold 1,300 units, right? That doesn't change from FIFO to LIFO, we still sold 1,300 units but what does change is which units, which unit cost we're going to pick from what we sold and which ones we're going to pick for what's left over. So in LIFO, the last units in are the first ones to sell, right?

So we're going to sell first the purchases on July 30th, okay? So the first units that we are going to take out of inventory are the 600 from July 30th, Right? Notice the difference from FIFO. In FIFO, we did the entirely opposite thing, right? So the 600 units times 2,330, I'm going to go ahead and leverage this math that we did down in this ending inventory before and that's going to tell us that this value was 13,980, right? That is 600 times 2,330, but we sold 1,300 units, right? We need to make our way up to 1,300 units, so we got to sell the next most recent. So we sold all those 600 most recent, the next is the 500, right? We've got 500 at a price of 22.40. Okay? But notice this still doesn't get us all the way to 1,300, right? This is still only 1,100 units. So 500 times 2,240, that's 11,200. Oops. Didn't mean to do that. 11,200. Okay? But remember, we're trying to get up to 1,300 units. So we got to sell 200 more and that's going to come from the July 1st balance, right? Because it's the only other units we have. So 200 units times the $20 price, that's going to be $4,000. 4,000.

So there we go. Notice we had to pull from 3 shipments in this case, right? Where before we only had 2 shipments to get to our total, but the key is to get to that 1,300 units. So let's add these up. 13,980 + 11,200 + 4,000. There we go. We're going to get 29,180. So that would be our cost of goods sold in a LIFO method. Notice that it's different from the cost of goods sold from a FIFO method and that's because we chose different units that were a different price for sale, okay? But there's not one that's more correct than the other, right? In the end, there's not one that's more correct. You just have to be consistent so that it's consistent from period to period, what you're showing to your users. So ending inventory, this one's going to be kind of easy. We only have 800 units in ending inventory just like it told us in the problem, 800 units on hand. Well, those are going to be the oldest units, right? Because we sold everything else, right? So in this case, what's going to be left over is the 800 units that are the oldest here which is from the inventory balance on July 1st, right? We sold everything else. So that's going to be 800 units times the $20 price and that's going to leave us with 800 times 20 is $16,000. 16,000. So that is our answer right there. That's the answer for the ending inventory. I'm going to go ahead and underline all the answers here just so we're a little clear with where the answers are. Cool. So there's LIFO. Let's go ahead and do the average cost method in the next video.

Periodic Inventory Average Cost Method

All right. So let's go ahead and do the average cost method for the same problem. So remember that average cost method, we have to find an average cost per unit, okay? So to do that, what we want to do is find the total cost of all the goods available for sale and that's where we're going to find the average, right? So far we know the quantity, we know the total quantity available for sale and I'm going to scroll up for a second just so you remember what formula I'm trying to use here. It's this average cost formula:Averagecost=totalcostquantity Okay? So we know the quantity. The quantity here is 2,100 units. What we need to know is the total cost, okay? So that's what we're gonna do right here. Let's first find the total cost and we're gonna do that in this purple box that I've added on the right-hand side. Alright, so we just go 1 by 1 here. The first thing was 1,000units×$20perunit, right? In our beginning balance, we had 1,000 units times $20 per unit, so we're just multiplying across here. Right? We're gonna multiply to find the total value of each shipment and this one was $20,000 for the beginning balance. Then we have 500 times $22.40 per and that's $11,200 and then the last shipment was 600 times 23.3 and that's $13,980. Okay. So there we go. We've got the total cost of each shipment. Let's go ahead and add them all together to get a total cost for everything. 13,980+11,200+20,000, we get a total value for all of these goods of 45,180. Okay? So now we know throughout the month and our beginning balance in total, the total value of all of that was 45,180 for 2,100 units, okay? So some of that's going to go to our cost of goods sold for the units we sold and some of that's going to end up in our ending inventory, okay? So remember, average cost, now we're ready to find our average cost per unit. We have our total cost and our total units. So let's figure it out. Our average cost which is what we're going to use throughout this problem is 45,1802,100, right? There's $45,180 in total cost and we're going to divide that to get a per-unit cost. So divided by 2,100 total units, that's going to give us a price of I'm going to round it here. $21.51 per unit, okay? So each unit is $21.51 now this gets really easy, that was the tricky part of this problem, now the last steps are really easy, right? So we know how many units we sold just like before, we had 2,100 total units minus the 800 left over that are in ending inventory. Well, 2,100-800, that's 1,300 units, right? Just like in all the other cases, we sold 1,300 units, but look how easy it is now. 1,300 units times our average cost, right? We're going to take our average cost over here, $21.51. Look how easy that is, right? We've got our average cost, 1,300, times $21.51. So that comes out to 2,000 7,963. Okay? So now that we know the total amount that's in cost of goods sold, well, everything else is just ending inventory, right? We had a total amount of cost minus this amount will get us to the ending inventory. Of course, I'll do it both ways just so you can see. We could just take the number in ending inventory, the eight 100 units times the average cost. So there are 2 ways we could do this. We could take the total cost of 45,180, right? That's the total cost that we calculated above minus the cost of goods sold, 27,963 and that's gonna give us our ending inventory. 45,180-27,963. Right? Because if we didn't sell it, well, then it's gonna be an ending inventory. 17,217. Okay? So that would be our ending inventory. Now of course, we could just do 800 times 2,151 our average cost, right? We could do the same thing 800 times our average cost sorry. Let me get out of the way and we would get probably very close to the same answer. I feel like there's gonna be a rounding error here and there is. We get 17,208 if we do it this way, right? So if we do it this way, there's gonna be those those $9 the difference there that isn't accounted for that's why this is a safer way to do it cause you're gonna make sure that you included all of the numbers in there, right? Cause we took the total cost and then subtracted the cost of goods sold we already calculated, Alright? Now this can only be a problem because we rounded, right? We rounded this number right here and that's why we got this bit of a discrepancy between the 2, but at the end of the day, you'd probably think that you know in a big company maybe the $9 isn't gonna be such a big deal, but you wanna account for every dollar and this is the best way to do it would be to just subtract the cost of goods sold that you calculated. Alright? So that's the average cost method. You can see it's pretty simple. Once you've capped once you find that average cost, well, it's just the number of units times that average cost. Cool? Alright, let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the difference between FIFO and LIFO in a periodic inventory system?

In a periodic inventory system, FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) are cost flow assumptions used to track cost of goods sold (COGS) and inventory. FIFO assumes that the oldest inventory items are sold first, meaning COGS reflects the cost of older inventory. Conversely, LIFO assumes that the newest inventory items are sold first, so COGS reflects the cost of newer inventory. These methods help manage inventory costs, especially when purchase prices fluctuate. Importantly, the physical flow of goods does not need to match these costing methods.

How is the average cost method calculated in a periodic inventory system?

The average cost method in a periodic inventory system calculates the cost of goods sold (COGS) by averaging the cost of all inventory items. To find the average cost per unit, you divide the total cost of all inventory purchases by the total number of units purchased. The formula is:

$\frac{\mathrm{Total} \mathrm{Cost}}{\mathrm{Total} \mathrm{Units}}$

This average cost per unit is then used to determine COGS and the value of ending inventory.

Why is the physical flow of goods not required to match the cost flow assumption in a periodic inventory system?

In a periodic inventory system, the physical flow of goods does not need to match the cost flow assumption (FIFO, LIFO, or average cost) because these methods are used solely for accounting purposes to track inventory costs. The actual physical movement of goods can differ based on practical considerations, such as expiration dates or storage logistics. The cost flow assumption is a way to systematically allocate costs to COGS and ending inventory, providing flexibility in inventory management without affecting the physical handling of goods.

How do you determine ending inventory in a periodic inventory system?

In a periodic inventory system, ending inventory is determined by physically counting the remaining units at the end of the accounting period. The formula used is:

$\mathrm{Ending} \mathrm{Inventory}=\mathrm{Beginning} \mathrm{Inventory}+\mathrm{Purchases}-\mathrm{Cost} \mathrm{of} \mathrm{Goods} \mathrm{Sold}$

This count reveals the quantity of items left, which is then valued using the chosen cost flow assumption (FIFO, LIFO, or average cost) to determine the monetary value of the ending inventory.

What are the advantages and disadvantages of using FIFO in a periodic inventory system?

Advantages of using FIFO in a periodic inventory system include: 1) It often matches the actual physical flow of goods, especially for perishable items. 2) It results in lower COGS during periods of rising prices, leading to higher reported profits. Disadvantages include: 1) It may not reflect current market conditions in COGS, as older, cheaper costs are used. 2) It can result in higher taxes due to higher reported profits. FIFO is beneficial for businesses where inventory turnover is high and prices are stable or rising.