The selling price has NOTHING to do with the cost. When calculating the Cost of Goods Sold for a sale, you must IGNORE the selling price. We will be using the perpetual inventory system in these examples which constantly updates the inventory account balance to reflect inventory on hand. However, it can be time consuming and not practical for homework and test situations so you learn the alternative method as well. Most computer systems will show you the Inventory Record form so you need to understand how to read it. You will see both because they are both beneficial. Okay, enough theory – how do these calculations work exactly? There are a couple of ways you can do them – there is an Inventory Record or a shortcut calculation. So, specific identification exactly matches the costs of the inventory with the revenue it creates. When a car dealership purchases a blue BMW convertible for $20,000 and later sells it for $60,000…they will want to show the exact cost of the BMW it sold as opposed to the cost of another car. This is most often used for high priced inventory – think car sales for example. Specific Identification – clearly, this will be your favorite method…it is the easiest to calculate in our examples because it specifically tells you which purchases inventory comes from.You will calculate a new Average Cost after each Purchase (Sales will not change the average cost). The weighted average method smooths out price changes so you have a steady stream of cost instead of sharp increases and decreases. Weighted Average (also called Average Cost) – this method is best used when the prices change from purchase to purchase and you want consistency.The Balance Sheet will show inventory at the oldest inventory costs and may not represent current market value. Cost of goods sold will reflect the current or most recent costs and are a better representation of matching since you are matching revenue will current costs of the inventory. LIFO (Last in, First out) – this means you will use the MOST RECENT inventory first to fill orders.FIFO shows the actual flow of goods…typically you will sell the oldest inventory before the newest inventory. This is an advantage because you are now reporting Inventory at the current cost which better reflects what it would cost to replace inventory if that would become necessary due to a disaster. The most recent costs are shown in the Inventory asset account balances and are provided on the Balance Sheet. This also means the oldest costs will appear in Cost of Goods Sold (since this is an Expense account this also means oldest costs will appear in the Income Statement). FIFO (First in, First out) – this means you will use the OLDEST inventory first to fill orders.The 4 methods of Cost of Goods Sold you will learn are: You will now learn how to calculate the Cost of Goods Sold using 4 different methods. Merchandise inventory (or inventory) is the quantity of goods available for sale at any given time. All merchandising companies have a quantity of goods on hand called merchandise inventory to sell to customers. For a merchandising company, the cost of goods sold can be relatively large. Even though we do not see the word Expense this in fact is an expense item found on the Income Statement as a reduction to Revenue. Remember, cost of goods sold is the cost to the seller of the goods sold to customers.
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