Inventories Valuation methods

Inventory Cost
· The net invoice price (less discounts) plus any freight and transit insurance plus taxes and tariffs.
· Inventory includes not only inventory on hand but also inventory in transit.

GAAP allows management to use four methods to evaluate inventory:
· Specific identification
· Average Cost method
· First in first out (FIFO)
· Last in first out (LIFO)

Specific identification
· Each unit purchased for resale is identified and accounted for by its invoice.
· Companies that use this method carry a small number of units.

Average Cost method
· All units in the inventory have the same value.
· Companies that use this method carry a large number of units.
· Effect of any price changes spread proportionately between COGS and ending inventory

FIFO
· Inventory acquired first is sold first. Ending inventory is valued close to its current market value but the COGS are based on old prices.

LIFO
· Inventory acquired last is sold first. COGS reflect the current cost of goods, but ending inventory is based on old prices.

Notes:
· In US, LIFO is popular due to its income tax benefits (higher cost of goods sold in an inflationary environment results in lower taxable income and thus lower income taxes. LIFO is prohibited under IRFS.