Inventory Cards: FIFO and Identified Cost Methods

Introduction to Inventory Cards

• Inventory: Goods purchased by a trading firm for resale to customers.
• Inventory Card: A document used in a perpetual inventory system to record each individual transaction involving the movement of inventory items. Tracks quantity and cost.
• Purpose:
  • Provides a continuous record of inventory on hand.
  • Calculates the cost of goods sold (COGS).
  • Supports accurate financial reporting.

KEY TAKEAWAY: Inventory cards are crucial for maintaining a real-time record of inventory levels and costs, directly impacting financial reporting accuracy.

Inventory Valuation Methods

Two primary methods are used to value inventory:

1. First-In, First-Out (FIFO): Assumes that the first units purchased are the first units sold.
2. Identified Cost: Tracks the actual cost of each individual item of inventory.

FIFO (First-In, First-Out)

• Principle: The oldest inventory items are assumed to be sold first.
• Impact on Cost of Sales (COGS): In periods of rising prices, FIFO results in a lower COGS and higher net profit.
• Impact on Inventory on Hand: The remaining inventory is valued at the most recent purchase prices.

Identified Cost

• Principle: Each item sold is specifically identified and its actual cost is recorded.
• Suitability: Best suited for businesses selling unique or high-value items where tracking individual costs is feasible (e.g., car dealerships, art galleries).
• Accuracy: Provides the most accurate valuation of COGS and inventory on hand.

EXAM TIP: Understand how FIFO and Identified Cost impact COGS and Net Profit, especially during periods of inflation or deflation.

Recording Transactions in Inventory Cards

The following transactions are recorded in inventory cards under both FIFO and Identified Cost methods:

1. Inventory Purchased

• FIFO: Record the quantity and cost of the purchased inventory in the ‘IN’ column. Update the ‘BALANCE’ column, keeping the cost layers separate (if applicable).
• Identified Cost: Record the quantity and cost of the purchased inventory in the ‘IN’ column, including any identifying information. Update the ‘BALANCE’ column.

2. Inventory Sold

• FIFO:
  • Determine the quantity sold.
  • Assign costs based on the oldest inventory first.
  • Record the quantity and cost of the sold inventory in the ‘OUT’ column.
  • Update the ‘BALANCE’ column, removing the sold inventory.
• Identified Cost:
  • Identify the specific items sold.
  • Record the quantity and cost of the sold inventory in the ‘OUT’ column.
  • Update the ‘BALANCE’ column, removing the sold inventory.

3. Inventory Returned (Purchase Returns)

• FIFO:
  • Treat as a reduction of the most recent purchase.
  • Record the quantity and cost of the returned inventory in the ‘OUT’ column (with a notation).
  • Update the ‘BALANCE’ column.
• Identified Cost:
  • Identify the specific items returned.
  • Record the quantity and cost of the returned inventory in the ‘OUT’ column.
  • Update the ‘BALANCE’ column.

4. Drawings of Inventory by the Owner

• FIFO:
  • Value the drawings based on the oldest inventory first.
  • Record the quantity and cost of the drawings in the ‘OUT’ column.
  • Update the ‘BALANCE’ column.
• Identified Cost:
  • Identify the specific items drawn.
  • Record the quantity and cost of the drawings in the ‘OUT’ column.
  • Update the ‘BALANCE’ column.

5. Inventory Used for Advertising

• FIFO:
  • Value the inventory used based on the oldest inventory first.
  • Record the quantity and cost of the advertising inventory in the ‘OUT’ column.
  • Update the ‘BALANCE’ column.
• Identified Cost:
  • Identify the specific items used for advertising.
  • Record the quantity and cost of the advertising inventory in the ‘OUT’ column.
  • Update the ‘BALANCE’ column.

6. Inventory Loss or Gain

• Inventory Count: A physical count of inventory on hand is conducted to verify the accuracy of inventory records.
• Inventory Loss: Occurs when the physical count is less than the inventory card balance.
• Inventory Gain: Occurs when the physical count is more than the inventory card balance.
• FIFO:
  • Inventory Loss: Value the loss based on the oldest inventory price.
  • Inventory Gain: Value the gain based on a reasonable estimate of current cost.
  • Record the loss/gain in the ‘OUT’/’IN’ column, respectively.
  • Update the ‘BALANCE’ column.
• Identified Cost:
  • Identify the specific items lost (if possible). If not, apply a reasonable estimate of cost.
  • Identify the specific items gained (if possible). If not, apply a reasonable estimate of cost.
  • Record the loss/gain in the ‘OUT’/’IN’ column, respectively.
  • Update the ‘BALANCE’ column.

7. Inventory Write-Down

• Definition: Reducing the value of inventory when its market value falls below its cost.
• Accounting Standard: Inventory should be valued at the lower of cost and net realisable value (NRV). NRV is the estimated selling price less any costs of completion and selling.
• Recording:
  • No entry in the inventory card itself.
  • The write-down is recorded as an expense in the income statement.
  • A note may be made in the inventory card for future reference.

COMMON MISTAKE: Forgetting to consider inventory write-downs when the market value of inventory declines.

Example Inventory Card (FIFO)

Example Inventory Card (Identified Cost)

STUDY HINT: Practice recording various transactions in inventory cards using both FIFO and Identified Cost methods. Pay close attention to the order of inventory flow under FIFO.

Relationship to General Journal and General Ledger

• Information from the inventory cards is used to prepare journal entries in the General Journal.
• These journal entries are then posted to the General Ledger accounts (e.g., Inventory, Cost of Sales).
• The inventory card provides the detailed breakdown to support the General Ledger balance.

Advantages and Disadvantages

VCAA FOCUS: Be prepared to discuss the advantages and disadvantages of each method and justify their application in different business scenarios.

Ethical Considerations

• Accurate Record Keeping: Maintaining accurate inventory records is crucial for ethical financial reporting.
• Consistent Application: Consistently applying the chosen inventory valuation method is essential.
• Transparency: Disclosing the inventory valuation method used in the financial statements.