Cost formulas
PAS 2, paragraph 25, expressly provides that the cost of inventories shall be determined by using
a. First in, First out
b. Weighted average
The standard does not permit anymore the use of the last in, first out (LIFO) as an alternative formula in
measuring cost of inventories.
First in, First out (FIFO)
The FIFO method assumes that "the goods first purchased are first sold" and consequently the goods
remaining in the inventory at the end of the period are those most recently purchased or produced.
In other words, the FIFO is in accordance with the ordinary merchandising procedure that the goods
are sold in the order they are purchased.
The rule is "first come, first sold".
The inventory is thus expressed in terms of recent or new prices while the cost of goods sold is
representative of earlier or old prices.
This method favors the statement of financial position in that the inventory is stated at current
replacement cost. The objection to the method is that there is improper matching of cost against
revenue because the goods sold are stated at earlier or older prices resulting in understatement of cost
of sales.
Accordingly, in a period of inflation or rising prices, the FIFO method would result to the highest net
income.
SP- @P3
200,000@2=400,000
100,000@1=100,000
300,000
500,000
Unit cost WA= 500,000/300,000=1.67
However, in a period of deflation or declining prices, the FIFO method would result to the lowest net
income.
SP- @P.25
200,000@2=400,000
100,000@1=100,000
300,000
500,000
Illustration – FIFO
The following data pertain to an inventory item:
Jan.
1
8
18
Beginning balance
Sale
Purchase
Units
800
Unit cost
200
Total cost
160,000
700
210
147,000
Sales (in units)
500
22
31
Sale
Purchase
800
500
220
110,000
The ending inventory is 700 units.
FIFO – Periodic
Units
200
500
700
From Jan. 18 Purchase
From Jan. 31 Purchase
Unit cost
210
220
Total cost
42,000
110,000
152,000
Cost of goods sold
Inventory - January 1
Purchases (147,000 + 110,000)
Goods available for sale
Inventory - January 31
Cost of goods sold
160,000
257,000
417,000
(152,000)
265,000
FIFO – Perpetual
This requires preparation of stock card.
Purchases
Date
Jan
Units
Unit cost
Sales
Total cost
Units
Unit cost
Balance
Total cost
1
8
18
500
700
210
500
220
100,000
147,000
22
31
200
300
200
60,000
500
210
105,000
110,000
Units
Unit cost
Total cost
800
200
160,000
300
200
60,000
300
200
60,000
700
210
147,000
200
210
42,000
200
210
42,000
500
220
110,000
NOTA BENE
Note well that under FIFO-periodic and FIFO-perpetual, the inventory costs are the same. In both cases,
the January 31, inventory is P152,000.
The cost of goods sold is determined for the stock card as follows:
January 8 sale
22 sale (60,000 + 105,000)
Cost of goods sold
Weighted average – Periodic
100,000
165,000
265,000
The cost of the beginning inventory plus the total cost of purchases during the period is divided by the
total units purchased plus those in the beginning inventory to get a weighted average unit cost.
Such weighted average unit cost is then multiplied by the units on hand to derive the inventory value.
In other word, the average unit cost is computed by dividing the total cost of goods available for sale
by the total number of units available for sale.
The preceding illustrative data are used.
Jan
Units
Unit cost
Total cost
Beginning balance
800
200
160,000
18
Purchase
700
210
147,000
31
Purchase
500
220
110,000
1
Total goods available for sale
Weighted average unit cost (417,000/2,000)
Inventory cost (700 x 208.50)
2,000
417,000
208.50
149,950
Cost of goods sold
Inventory - January 1
Purchases (147,000 + 110,000)
Goods available for sale
Inventory - January 31
Cost of goods sold
160,000
257,000
417,000
(149,950)
271,050
OR
1,300x208.5=271,050
Weighted average – Perpetual
When used in conjunction with the perpetual system, the weighted average method is popularly known
as the moving average method.
PAS 2, paragraph 27, provides that the weighted average may be calculated on a periodic basis or as
each additional shipment is received depending upon the circumstances of the entity.
Under this method, a new weighted average unit cost must be computed after every purchase and
purchase returns.
Thus, the total cost of goods available after every purchase and purchase return is divided by the total
units available for sale at this time to get a new weighted average unit cost.
Such new weighted average unit cost is then multiplied by the units on hand to get the inventory cost.
This method required the keeping of stock card in order to monitor the “moving” unit cost after every
purchase.
Jan
1
8
18
22
31
Beginning balance
Sale
Balance
Purchase
Total
Sale
Balance
Purchase
Total
Units
800
(500)
300
700
1,000
(800)
200
500
700
Unit cost
200
200
200
210
207
207
207
220
216
Total cost
160,000
(100,000)
60,000
147,000
207,000
(165,600)
41,400
110,000
151,400
Observe that a new weighted average unit cost is computed after every purchase.
Thus, after the January 18 purchase, the total cost of P207,000 is divided by 1,000 units to get a weighted
average unit cost of P207.
After the January 31 purchase, the total cost of P151,400 is divided by 700 units to get a new weighted
average unit cost of P216.
Cost of goods sold from the stock card
January 8 Sale
22 Sale
Cost of goods sold
100,000
165,600
265,600
The argument for the weighted average method is that it is relatively easy to apply, especially with
computers. Moreover. The weighted average method produces inventory valuation that approximates
current value if there is a rapid turnover of inventory.
The argument against the weighted average method is that there may be a considerable lag between
the current cost and inventory valuation since the average unit cost involves early purchases.
Last in, Fist out (LIFO)
The LIFO method assumes that “the good last purchased are first sold” and consequently the goods
remaining in the inventory at the end of the period are those first purchased or produced.
The inventory is thus expressed in terms of earlier or old prices and the cost of goods sold is representative
of recent or new prices.
The LIFO favors the income statement because there is matching of current cost against current
revenue, the cost of goods sold being expressed in terms of current or recent cost.
The objection of the LIFO is that the inventory is stated at earlier or older prices and therefore there may
be a significant lag between inventory valuation and current replacement cost.
Moreover, the use of LIFO permits income manipulation, such as by making year-end purchases
designed to preserve existing inventory layers. At times these purchases may not even be in the best
economic interest of the entity.
Actually, in a period of rising prices, the LIFO method would result to the lowest net income. In a period
of declining prices, the LIFO method would result to the highest net income.
LIFO – Periodic
In the preceding illustration, the cost of 700 units under the LIFO is computed as follows.
Units
700
From January 1 balance
Unit cost
200
Total cost
140,000
Cost of goods sold under LIFO – periodic
Inventory - January 1
Purchases (147,000 + 110,000)
Goods available for sale
Inventory - January 31
Cost of goods sold
160,000
257,000
417,000
(140,000)
277,000
LIFO – Perpetual
This requires the preparation of stock card.
Purchases
Date
Jan
Units
Unit cost
Sales
Total cost
Units
Unit cost
Balance
Total cost
1
8
18
500
700
210
500
220
100,000
147,000
22
31
200
700
210
147,000
100
200
20,000
110,000
Units
Unit cost
Total cost
800
200
160,000
300
200
60,000
300
200
60,000
700
210
147,000
200
200
40,000
200
220
40,000
500
220
110,000
Note well the LIFO-periodic and LIFO-perpetual differ in inventory value.
Under LIFO periodic, the January 31 inventory is P140,000 and under LIFO perpetual, the January 31
inventory is P150,000.
Another illustration
Jan.
1
10
15
16
30
Beginning balance
Purchase
Sale
Sale return
Purchase
Units
5,000
5,000
(7,000)
1,000
16,000
Unit cost
200
250
Total cost
1,000,000
1,250,000
150
2,400,000
31
Purchase return
Ending balance
(2,000)
18,000
150
300,000
FIFO – whether periodic or perpetual
Jan
Units
Unit cost
Total cost
10
Purchase
4,000
250
1,000,000
30
Purchase
14,000
150
2,100,000
18,000
3,100,000
Specific Identification
The January 30 purchase of 16,000 units is reduced by the purchase return of 2,000 units or net purchase
of 14,000 units. Note that under FIFO perpetual, the sale return of 1,000 units on January 16 would be
costed back to inventory at the latest purchase unit cost of P250 before the sale.
Moving average – Perpetual
Jan
1
10
15
16
30
31
Jan
1
10
15
15
16
30
31
Beginning balance
Purchase
Balance
Sale
Balance
Sale return
Balance
Purchase
Balance
Purchase return
Balance
Units
5,000
5,000
10,000
(7,000)
3,000
1,000
4,000
16,000
20,000
(2,000)
18,000
Unit cost
200
250
225
225
225
225
225
150
165
150
167
Total cost
1,000,000
1,250,000
2,250,000
(1,575,000)
675,000
225,000
900,000
2,400,000
3,300,000
(300,000)
3,000,000
Beginning balance
Purchase
Balance
Sale
Balance
Purchase
Balance
Sale return
Balance
Purchase
Balance
Purchase return
Balance
Units
5,000
5,000
10,000
(7,000)
3,000
5,000
8,000
1,000
9,000
16,000
20,000
(2,000)
18,000
Unit cost
200
250
225
225
225
260
247
225
225
150
165
150
167
Total cost
1,000,000
1,250,000
2,250,000
(1,575,000)
675,000
1,300,000
1,975,000
225,000
900,000
2,400,000
3,300,000
(300,000)
3,000,000
Observe that the moving average unit cost changes every time there is a new purchase or a purchase
return. The moving average unit cost is not affected by a sale or a sale return.
Weighted average – Periodic
Jan
Units
Unit cost
Total cost
Beginning balance
5,000
200
1,000,000
10
Purchase
5,000
250
1,250,000
30
Purchase
16,000
150
2,400,000
31
Purchase return
(2,000)
150
(300,000)
1
24,000
Weighted average unit cost (P4,350,000/24,000 units)
Cost of ending inventory (18,000 x 181.25)
4,350,000
181.25
3,262,500
Specific identification
Specific identification means that specific costs are attributed to identified items of inventory.
The cost of the inventory is determined by simply multiplying the units on hand by their actual unit cost.
This requires records which will clearly determine the actual costs of the goods on hand.
PAS 2, paragraph 23, provides that this method is appropriate for inventories that are segregated for a
specific project and inventories that are not ordinarily interchangeable.
The major argument for this method is that the flow of the inventory cost corresponds with the actual
physical flow of goods.
With specific identification, there is an actual determination of cost of units sold and on hand.
The major argument against this method is that it is very costly to implement even with high-speed
computers.
Standard costs
Standard costs are predetermined product costs established on the basis of normal levels of materials
and supplies, labor, efficiency and capacity utilization.
Observe that a standard cost is predetermined and, once determined, is applied to all inventory
movements – inventories, goods available for sale, purchases and goods sold or placed in production.
PAS 2, paragraph 21, states that the standard cost method may be used for convenience if the results
approximate cost.
However, the standards set should be realistically attainable and are reviewed and revised regularly in
the light of current conditions.
Standard costing is taken up in higher accounting course and is not discussed further in this book.
Relative sales price method
When different commodities are purchased at a lump sum, the single cost is apportioned among the
commodities based on their respective sales price. This is based on the philosophy that cost is
proportionate to selling price.
For example, products A, B, and C are purchased at “basket price” of P3,000,000. Assume that the said
products have the following sales price: A P500,000, B P1,500,000, and C P3,000,000.
Computation of cost of each product
Product A
Product B
Product C
500,000
1,500,000
3,000,000
5,000,000
5/50 x 3,000,000
15/50 x 3,000,000
30/50 x 3,000,000
300,000
900,000
1,800,000
3,000,000
References
Valix, C. & Valix, C.A. (2018). Practical Accounting 1 vol 1. GIC Enterprises and Co., Inc. Manila,
Philippines
Valix, C. & Valix, C.A. (2013). Theory of Accounts 2013 edition. GIC Enterprises and Co., Inc. Manila,
Philippines
Valix, C. Valix, C.A. (2019). Intermediate Accounting 1. GIC Enterprises and Co., Inc. Manila,
Philippines
Robles, N. & Empleo P. (2016). The Intermediate Accounting Series Vol 2. Millenium Books, Inc.,
Mandaluyong City
Uberita, C. (2012). Practical Accounting 1 2013 Edition. GIC Enterprises and Co, Inc. Manila, Philippines