10.1 Describe and Demonstrate the Basic Inventory Valuation Methods and Their Cost Flow Assumptions

The total cost of goods available for sale is a combination of the beginning inventory plus new inventory purchases. These costs relating to goods available for sale are included in the ending inventory, reported on the balance sheet, or become part of the cost of goods sold reported on the income statement.
Merchandise inventory is maintained using either the periodic or the perpetual updating system. Periodic updating is performed at the end of the period only, whereas perpetual updating is an ongoing activity that maintains inventory records that are approximately equal to the actual inventory on hand at any time.
There are four basic inventory cost flow allocation methods, which are alternative ways to estimate the cost of the units that are sold and the value of the ending inventory. The costing methods are not indicative of the flow of the goods, which often moves in a different order than the flow of the costs.
Utilizing different cost allocation options results in marked differences in reported cost of goods sold, net income, and inventory balances.

10.2 Calculate the Cost of Goods Sold and Ending Inventory Using the Periodic Method

The periodic inventory system updates inventory at the end of a fixed accounting period. During the accounting period, inventory records are not changed, and at the end of the period, inventory records are adjusted for what was sold and added during the period.
Companies using the periodic and perpetual method for inventory updating choose between the basic four cost flow assumption methods, which are first-in, first-out (FIFO); last-in, first-out (LIFO); specific identification (SI); and weighted average (AVG).
Periodic inventory systems are still used in practice, but the prevalence of their use has greatly diminished, with advances in technology and as prices for inventory management software have significantly decreased.

Perpetual inventory systems maintain inventory balance in the company records in a real-time or slightly delayed, continuously updated state. No significant adjustments are needed at the end of the period, before issuing the financial statements.
Companies using the perpetual method for inventory updating choose between the basic four cost flow assumption methods, which are first-in, first-out (FIFO); last-in, first-out (LIFO); specific identification (SI); and weighted average (AVG).
Most modern inventory systems utilize the perpetual inventory system, due to the benefits it offers for efficiency, ease of operation, availability of real-time updating, and accuracy.

The value for cost of the goods available for sale is dependent on accurate beginning and ending inventory numbers. Because of the interrelationship between inventory values and cost of goods sold, when the inventory values are incorrect, the associated income statement and balance sheet accounts are also incorrect.
Inventory errors at the beginning of a reporting period affect only the income statement. Overstatements of beginning inventory result in overstated cost of goods sold and understated net income. Conversely, understatements of beginning inventory result in understated cost of goods sold and overstated net income.
Inventory errors at the end of a reporting period affect both the income statement and the balance sheet. Overstatements of ending inventory result in understated cost of goods sold, overstated net income, overstated assets, and overstated equity. Conversely, understatements of ending inventory result in overstated cost of goods sold, understated net income, understated assets, and understated equity.

Inventory ratio analysis tools help management to identify inefficient management practices and pinpoint troublesome scenarios within their inventory operations processes.
The inventory turnover ratio measures how fast the inventory sells, which can be useful for inter-period comparison as well as comparisons with competitor firms.
The number of days’ sales in inventory ratio indicates how long it takes for inventory to be sold, on average, which can help the firm identify instances of too much or too little inventory, indicating such cases as product obsolescence or excess stocking, or the reverse scenario: insufficient inventory, which could result in customer dissatisfaction and lost sales.