CFA 29: Inventories Flashcards
Specific Identification
Inventory Valuation Methods
Used for inventory items that are not ordinarily interchangeable and for goods that have been produced and segregated for specific projects. This method is also commonly used for expensive goods that are uniquely identifiable, such as precious gemstones. Under this method, the cost of sales and the cost of ending inventory reflect the actual costs incurred to purchase (or manufacture) the items specifically identified as sold and the items specifically identified as remaining in inventory. Therefore, this method matches the physical flow of the specific items sold and remaining in inventory to their actual cost.
First-In, First-Out (FIFO)
Inventory Valuation Methods
FIFO assumes that the oldest goods purchased (or manufactured) are sold first and the newest goods purchased (or manufactured) remain in ending inventory. In other words, the first units included in inventory are assumed to be the first units sold from inventory. Therefore, cost of sales reflects the cost of goods in beginning inventory plus the cost of items purchased (or manufactured) earliest in the accounting period, and the value of ending inventory reflects the cost of goods purchased (or manufactured) more recently.
In periods of rising prices, the costs assigned to the units in ending inventory are higher than the costs assigned to the units sold. Conversely, in periods of declining prices, the costs assigned to the units in ending inventory are lower than the costs assigned to the units sold.
Weighted Average Cost
Inventory Valuation Methods
Weighted average cost assigns the average cost of the goods available for sale (beginning inventory plus purchase, conversion, and other costs) during the accounting period to the units that are sold as well as to the units in ending inventory.
In an accounting period, the weighted average cost per unit is calculated as the total cost of the units available for sale divided by the total number of units available for sale in the period (total cost of goods available for sale/ total units available for sale).
Last-In, First-Out (LIFO)
Inventory Valuation Methods
LIFO is permitted only under US GAAP. This method assumes that the newest goods purchased (or manufactured) are sold first and the oldest goods purchased (or manufactured), including beginning inventory, remain in ending inventory.
In other words, the last units included in inventory are assumed to be the first units sold from inventory. Therefore, cost of sales reflects the cost of goods purchased (or manufactured) more recently, and the value of ending inventory reflects the cost of older goods.
In periods of rising prices, the costs assigned to the units in ending inventory are lower than the costs assigned to the units sold. Conversely, in periods of declining prices, the costs assigned to the units in ending inventory are higher than the costs assigned to the units sold.
net realisable value
Measurement of Inventory Value
The estimated selling price in the ordinary course of business less the estimated costs necessary to get the inventory in condition for sale and to make the sale.
Under IFRS, inventories are measured at the lower of cost and net realisable value.
Under US GAAP, inventory is measured at the lower of cost or market. Market value is defined as current replacement cost subject to upper and lower limits. Market value acannot exceed net realisable value (selling price less reasonably estimated costs of completion and disposal). The lower limit of market value is net realisable value less a normal profit margin. Any write-down reduces the value of the inventory, and the loss in value (expense) is generally reflected in the income statement in cost of goods sold.
US GAAP prohibit the reversal of a write-down; this rule is different from the treatment under IFRS.
