In this section, we will delve into the various methods used to determine the cost of inventory in a periodic inventory system. A periodic inventory system is a system that determines the cost of merchandise sold and inventory at the end of the period. This means that we must record the cost of merchandise sold and reductions in inventory as sales occur using a perpetual inventory system. It is important to properly assign costs to inventory and cost of merchandise sold as it affects the reported amounts for both systems.
There are four commonly used methods for assigning costs to inventory and cost of merchandise sold in a periodic inventory system. These include:
- Specific identification: This method is used when each item in inventory can be directly identified with a specific purchase and its invoice. It is appropriate for small volumes of sales and a small variety of merchandise.
- First-in, first-out (FIFO): This method assumes that inventory items are sold in the order they were acquired. This means that the cost flow is in the order in which the expenditures were made.
- Last-in, first-out (LIFO): This method assumes that the most recent purchases are sold first. Their costs are charged to cost of goods sold and the costs of the earliest purchases are assigned to inventory.
- Weighted average: This method requires computing the average cost per unit of merchandise available for sale. The cost flow is an average of the expenditures.