Methods of Calculating the Cost of Inventory

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We will explain three main methods of calculating cost of inventory: specific cost, FIFO  (First in, First out) and AVCO (average cost).

Specific cost: When items of inventory are individually distinguishable and of high value, so we will use unit cost (actual cost or specific cost).

FIFO or AVCO (average cost) : Where inventories consist of a large number of interchangeable (ie identical or very similar) items, so we will use FIFO or AVCO (average cost). LIFO(last-in, first-out) is not allowed under International Financial Reporting Standard (IFRS).

FIFO- is a method of estimating cost which assumes that inventory is used or sold in the same order that it is purchased by the business.

 AVCO (average cost)- method of estimating cost which assumes that all inventory purchased is mixed together. This assumption would be true for liquid inventory. There are two possible methods for AVCO (average cost):

1. Continuous weighted average= (inventory value of items in stores + purchase cost of units received)/(Quantity already in stores + Quantity received)
2. Periodic weighted average (simple weighted average)= ( cost of opening inventory + cost of all receipts in the period)/(units in opening inventory + units received)

Example:

ABC Company purchases and sells Phone Y

In November 1,000 units were purchased and 800 units sold as follows:

3 November                                       400 units purchased at $60 per unit

5 November                                       200 units sold

11 November                                    300 units at $70 per unit

14 November                                    200 units sold

21 November                                    300 units at $80 per unit

22 November                                    200 units sold

27 November                                    200 units sold

First In First Out (FIFO) Method:

Date	Receipts	Sold	Balance
			No. of inventory	$
3 Nov	400 x $60		400	24,000
5 Nov		200 x $60	200	12,000
11 Nov	300 x $70		500	33,000
14 Nov		200 x $60	300	21,000
21 Nov	300 x $80		600	45,000
22 Nov		200 x $70	400	31,000
27 Nov		100 x $70 100 x $80	200	16,000
Cost of sale is $53,000 and the value of closing inventory is $16,000.

Continuous Weighted Average Cost (AVCO) Method:

Weighted average cost is calculated each time that there is a new delivery into stores.

Weighted average price = (inventory value of items in stores + purchase cost of units received)/(Quantity already in stores + Quantity received)

Date	Quantity	Purchase Price	Value	Weighted average price
		$	$	$
3 Nov	400	60	24,000	60
5 Nov	(200)		(12,000)	60
	200		12,000	60
11 Nov	300	70	21,000
Balance	500		33,000	66 (33,000/500)
14 Nov	(200)		(13,200)	66
	300		19,800	66
21 Nov	300	80	24,000
Balance	600		43,800	73(43,800/600)
22 Nov	(200)		(14,600)	73
27 Nov	(200)		(14,600)	73
30 Nov	200		14,600	73
Cost of sale is $54,400 and the closing inventory is $14,600.

Periodic Weighted Average Cost Method:

Period weighted average price= ( cost of opening inventory + cost of all receipts in the period)/(units in opening inventory + units received)

Periodic weighted average price = (400×60+300×70+300×80)/(400+300+300)=$69 per unit.

Cost of sale = 800 units x 69$=$55,200

Inventory of end period = 200 units x 69$=$13,800