## 3. Cost flow methods under different inventory systems (perpetual and periodic)

We have seen how cost flow methods are applied if we have multiple layers, however arranged in a way so that sales go after purchases. But what happens if sales and purchases are mixed, like one purchase is followed by one sale, then again followed up by purchase(s) and sale(s)? In those situations nothing is different and all rules for FIFO, LIFO and weighted-average hold true. The following example will give you a good illustration of applying FIFO and LIFO for sales transactions that occur intermittently with purchases.

Assume a trading company with the following information in the first half of 20X7:

 Jan 1 Beginning Inventory 50 units x \$10 (at cost) Feb 25 Purchase 100 units x \$12 (at cost) Mar 3 Sale 120 units x \$20 (at selling price) Mar 3 Cost of Sale 120 units x TBD (at cost) Apr 6 Purchase 60 units x \$14 (at cost) May 17 Sale 70 units x \$25 (at selling price) May 17 Cost of Sale 70 units x TBD (at cost)

TBD - cost to be determined, see below

The total number of goods available for sale for the period is 210 units (50 + 100 + 60).
The total number of goods sold during the period is 190 units (120 + 70).
The ending inventory at period end is 20 units (210 - 190).

## 3.1. Example of FIFO cost flow method under perpetual system

Recall that a perpetual inventory system means the inventory accounts are adjusted after each sale or purchase transaction. Under FIFO, the cost of the goods that were acquired by the company first, is transferred from Inventory to Cost of Goods Sold upon a sale. In other words, when a sale takes place, the cost of units from the earliest inventory layer is expensed first. If there are not enough units in the first layer, the unit cost from the next layer is expensed and so on like that.

In our example, on March 3 the company sold 120 units. To calculate the cost of goods sold for the 120 units, we take the 50 units from the first layer (beginning inventory, \$10 per unit) and 70 items from the second layer (purchased on February 25, \$12 per unit).

Next, on May 17, additional 70 units were sold. The cost of goods sold for the 70 units is computed by adding the cost of 30 (i.e., 100 - 70) units remaining from the second layer (purchased on February 25, \$12 per unit) and 40 units from the third layer (purchased on April 6, \$14 per unit). The computation of the total cost of goods sold is as follows:

Illustration 9: Example of FIFO cost flow method under perpetual system

 Date Purchase Cost of Goods Sold Inventory Units x Cost = Total Units x Cost = Total Units x Cost = Total Jan 1 50 x \$10 = \$500 Feb 25 100 x \$12 = \$1,200 50 x \$10 = \$500 100 x \$12 = \$1,200 Mar 3 50 x \$10 = \$500 70 x \$12 = \$840 30 x \$12 = \$360 Apr 6 60 x \$14 = \$840 30 x \$12 = \$360 60 x \$14 = \$840 May 17 30 x \$12 = \$360 40 x \$14 = \$560 20 x \$14 = \$280 Total COGS = \$2,260 End. Inventory = \$280
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