Inventory Methods - Gestão de Estoque

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NAME: RICARDO GUIA
METHODS OF INVENTORY
	Inventories are materials, work in process, finished goods, etc. that are considered to be portion of a business’s assets that are ready or will be ready for sale. For many companies, inventories are a significant portion of total assets, due to that they have big importance in the company value. The companies operate in different sectors, so for a better explanation we can categorize in:
Merchandise inventory: goods on hand purchased by a retailer or a trading company such as an importer or exporter for resale.
Raw materials inventory: Tangible goods purchased or obtained in other ways (e.g., by mining) and on hand for direct use in the manufacture or further processing of goods for resale. 
Work-in-process inventory: Goods or natural resources requiring further processing before completion and sale. 
Finished goods inventory: Manufactured or fully processed items completed and held for sale.
Production supplies inventory: items on hand, such as lubrication oils for the machinery, cleaning materials, as well as small items that make up an insignificant part of the finished product, such as bolts or glue.
Contracts in progress: the accumulated costs of performing services required under contract.
Miscellaneous inventories: items such as office, janitorial, and shipping supplies. 
Basic formulation for inventory:
In addition, there are 2 types of inventory system:
Periodic inventory system: inventory value is determined only at particular times, such as end of the accounting period.
Perpetual inventory system: the ongoing physical flow of inventory is monitored, and the cost of the inventory items is maintained on a continual basis.
The price of suppliers is not constant due to the variations in the market. Then, the cost will also change along the time. Seeking for a better estimation of this cost, the company can decide which costing method they are going to use. Some of the methods are:
SPECIFIC IDENTIFICATION METHOD
The specific identification method refers to the tracking and costing of inventory based on the movement of specific, identifiable inventory items in and out of stock. This method is applicable when individual items can be clearly identified, such as with a serial number, stamped receipt date, or RFID tag. 
This method is rarely used, because there are few purchased products that are clearly identified in a company's accounting records with a unique identification code. Thus, it is typically restricted to unique, high-value items for which such differentiation is needed. 
AVERAGE COST METHOD	
The cost average cost method calculates the cost of ending inventory and cost of goods sold for a period on the basis of weighted average cost per unit of inventory. Weighted average cost per unit is calculated using the following formula:
	
Average
	=
	Total Cost of Inventory
	Cost
	
	Total Units in Inventory
Average cost method is applied differently in periodic inventory system and perpetual inventory system. In periodic inventory system, average cost per unit is calculated for the entire class of inventory. It is then multiplied with number of units sold and number of units in ending inventory to arrive at cost of goods sold and value of ending inventory respectively. In perpetual inventory system, we have to calculate the weighted average cost per unit before each sale transaction.
Example (for periodic system):
	DATE
	TYPE
	UNITS
	COST/UNIT
	5/1/14
	Beginning Inventory
	60
	 $15.00 
	5/5/14
	Purchase
	140
	 $15.50 
	5/12/14
	Sale
	190
	 $19.00 
	5/15/14
	Purchase
	70
	 $16.00 
	5/15/14
	Sale
	30
	 $19.50 
Then, Calculating the cost of goods sold:
	
	Units
	Unit Cost
	Total
	
	60
	 $15.00 
	900
	
	140
	 $15.50 
	2170
	
	70
	 $16.00 
	1120
	Average cost unit
	270
	 $15.52 
	4190
	
	
	
	
	Cost of goods Sold
	220
	$15.52
	$3,414.07
FIRST-IN, FIRST-OUT (FIFO)
	The first-in, first-out method assumes that the first goods purchased are also the first goods sold. It provides the same results for periodic and perpetual inventory system. In most companies, this assumption closely matches the actual flow of goods, and so is considered the most theoretically correct inventory valuation method. The FIFO flow concept is a logical one for a business to follow, since selling off the oldest goods first reduces the risk of obsolescence.
	 The earliest goods purchased are the first ones removed from the inventory account. This results in the remaining items in inventory being accounted for at the most recently incurred costs, so that the inventory asset recorded on the balance sheet contains costs quite close to the most recent costs that could be obtained in the marketplace. Conversely, this method also results in older historical costs being matched against current revenues and recorded in the cost of goods sold; this means that the gross margin does not necessarily reflect a proper matching of revenues and costs. For example, in an inflationary environment, current-cost revenue dollars will be matched against older and lower-cost inventory items, which yields the highest possible gross margin.
Example:
	DATE
	TYPE
	UNITS
	COST/UNIT
	5/1/14
	Beginning Inventory
	68
	 $15.00 
	5/5/14
	Purchase
	140
	 $15.50 
	5/9/14
	Sale
	94
	 $19.00 
	5/11/14
	Purchase
	40
	 $16.00 
	5/16/14
	Purchase
	78
	 $16.50 
	5/20/14
	Sale
	116
	 $19.50 
	5/29/14
	Sale
	62
	 $21.00 
For the end of April:
	Units Available for Sale
	326
	Units Sold
	
	272
	Units in Ending Inventory
	54
	
	Units
	Unit Cost
	Total
	
	68
	 $15.00 
	 $1,020.00 
	
	140
	 $15.50 
	 $2,170.00 
	
	40
	 $16.00 
	 $640.00 
	
	24
	 $16.50 
	 $396.00 
	Cost Of goods sold
	272
	 
	 $4,226.00 
	
	
	
	
	Inventory from 5/16/14
	54
	 $16.50 
	 $891.00 
Note: For the periodic and perpetual inventory system we have the same result.
LAST-IN, FIRST-OUT (LIFO)
	The last in, first out method assumes that the last item of inventory purchased is the first one sold. Picture a store shelf where a clerk adds items from the front, and customers also take their selections from the front; the remaining items of inventory that are located further from the front of the shelf are rarely picked, and so remain on the shelf – that is a LIFO scenario. 
The problem with the LIFO scenario is that it is rarely encountered in practice. If a company were to use the process flow embodied by LIFO, a significant part of its inventory would be very old, and likely obsolete. Nonetheless, a company does not actually have to experience the LIFO process flow in order to use the method to calculate its inventory valuation.
The reason why companies use LIFO is the assumption that the cost of inventory increases over time, which is a reasonable assumption in times of inflating prices. The cost of the most recently acquired inventory will always be higher than the cost of earlier purchases, so your ending inventory balance will be valued at earlier costs, while the most recent costs appear in the cost of goods sold. By shifting high-cost inventory into the cost of goods sold, a company can reduce its reported level of profitability, and thereby defer its recognition of income taxes.
Example (periodic system):
	DATE
	TYPE
	UNITS
	COST/UNIT
	5/1/14
	Beginning Inventory
	60
	 $15.00 
	5/5/14
	Purchase
	140
	 $15.50 
	5/14/14
	Sale
	190
	 $19.00 
	5/27/14
	Purchase
	70
	 $16.00 
	5/29/14
	Sale
	30
	 $19.50 
For the of April:
	Units Available for Sale
	270
	Units Sold
	
	220
	Units in Ending Inventory
	50
	
	
	
	Units
	Unit Cost
	Total
	
	70
	 $16.00 
	 $1,120.00 
	
	140
	 $15.50 
	 $2,170.00 
	
	10
	 $15.00 
	 $150.00 
	Cost Of goods sold
	220
	 
	 $3,440.00 
	
	
	
	
	Ending Inventory
	50
	 $15.00$750.00 
FIFO X LIFO analysis:
	If purchases prices are:
	Impact on the ending inventory
	Impact on Cost of Goods Sold
	 Impact on the Net Income and Retained Earnings
	Rising
	FIFO > LIFO
	FIFO < LIFO
	FIFO > LIFO
	Falling
	FIFO < LIFO
	FIFO > LIFO
	FIFO < LIFO