In this chapter, we will be discussing the process of determining the cost of inventory in an organization. Inventory refers to the goods and materials that a company holds for sale or for use in the production of goods to be sold. Determining the cost of inventory is an important aspect of managing a business, as it helps the organization to determine the value of their inventory and to make informed decisions about how to allocate their resources.
The cost of inventory includes not only the purchase price of the goods, but also any added or incidental costs that are necessary to bring the goods to a salable condition and location. These costs may include import duties, transportation, storage, insurance, and any costs incurred in the aging process of the goods (such as the aging of wine or cheese).
There are two main types of inventory systems: periodic and perpetual. A periodic inventory system determines the cost of merchandise sold and the ending inventory at the end of a specific period. In contrast, a perpetual inventory system records the cost of merchandise sold and reductions in inventory as sales occur. The method that an organization uses to assign costs to inventory and the cost of merchandise sold can have an impact on the reported amounts for both systems.
There are four commonly used methods for assigning costs to inventory and the cost of merchandise sold: specific identification, first-in first-out (FIFO), last-in first-out (LIFO), and weighted average. In the following sections, we will explore each of these methods in detail and discuss how they are used to determine the cost of inventory in a business.