6.

01 Inventory Control
Methods
Understand Inventory Control Methods

PowerPoint #3
Inventory Control Methods
 Help businesses account for Ending Inventory
and help determine Cost of Goods Sold
 If Inventory consists of large, identifiable

items, it is easy to compute the above.

 If Inventory consists of lots of items that are

not specifically identifiable, such as in a

hardware store, it is not very easy to compute
the above.
 Businesses use Inventory Control Methods to

help with these computations.

Assumptions
 Because of fluctuations in purchase price of
the inventory, businesses must make
assumptions about which items have sold
and which remain.
 These Methods are:
◦ Specific Identification
◦ First In First Out
◦ Last In Last Out
◦ Weighted Average
Specific Identification
 The actual cost of each item is assigned to
the item.
 Firms that sell big ticket items such as cars,
appliances, or furniture may use specific
identification.
 This method is rarely used in practice today.
First In First Out
 Based on the assumption that the first items
purchased are the first items sold
 Assumes the newest acquired items remain in

inventory
 During periods of inflation, FIFO will result in

the lowest Cost of Goods Sold and the

highest income.
Last In First Out
 Based on the assumption that the last items
purchased are the first items sold
 Assumes the oldest acquired items remain in

inventory.
 During periods of inflation, the use of LIFO

results in the highest Cost of Goods Sold and

the lowest income.
Weighted Average
 Assigns an average cost to each unit in
inventory
 This average unit price is calculated prior to

each sale.
 This method results in a Cost of Goods Sold

amount that is between the FIFO and LIFO

amounts.
Lower of Cost or Market
 Lower of Cost or Market is not an inventory
method, it is an application of the GAAP
principle of Conservatism.
 Per GAAP, inventory is valued at historical cost.
 Sometimes, the original cost of the ending
inventory is more than its replacement cost.
 If inventory has decreased significantly below
historical cost, the Lower of Cost or Market is
used.
Lower of Cost or Market (cont’d)
 First, inventory is calculated by one of the
inventory control methods.
 Next, inventory value is compared to market
value to determine if an adjustment should
be made.
 The difference is charged to the Cost of
Goods Sold account or to a special Loss
Account if material.
Questions for
Understanding/Discussion
 Why would a hardware store opt to account
for inventory using an inventory control
method rather than count each individual bin
of nails, screws, and bolts?
 Explain the differences between the four

inventory control methods?

 Summarize each of the four methods in your

own words.
 Explain why the lower of cost or market

method is used by companies.