Inventory Management

INVENTORY MANAGEMENT

ONE OF THE MOST EMBARRASSING

SITUATIONS FOR A SUPPLY CHAIN MANAGER IS TO RUN OUT OF STOCK EVENTUALLY BRINGING

CERTAIN OPERATIONS TO A HALT.

SO WHAT?

HAVE MORE INVENTORY – NO STOCKOUTS

BUT THEN WHAT ABOUT……INVENTORY CARRYING COSTS !!!

INTRODUCTION

• Inventory decisions are high-risk and high-impact from the perspective of logistics operations.

• Inventory assortment and subsequent shipment in anticipation of future sales determine a number of logistics activities.

• Without proper coordination, sales may be lost and customer satisfaction may also decline.

• Also critical to manufacturing.• RM shortages can shut down the line or modify a

production schedule leading to added costs and FG shortages.

• Overstock inventories can also increase costs and reduce profitability through added warehousing, working capital requirements, deterioration, insurance, taxes, and obsolescence.

NOTE IT……..

• Constitutes significant part of current assets

• On an average approximately 60% of current assets in Public Limited Companies in India.

• A considerable amount of fund is required

• Effective and efficient management is imperative to avoid unnecessary investment.

Basic Concept

Input Purchase ----------> Input Utilized Product value realized

Time

Inventory

Inventory

Inputs• Raw Materials• Purchased parts• Maintenance and

Repair Materials

Outputs• Finished Goods• Scrap and Waste

Process

In Process• Partially

Completed Products and Subassemblies

(in warehouses, or “in transit”)

(often on the factory floor)

Inventory

Work inprocess

Work inprocess

Work inprocess

Finishedgoods

RawMaterials

Vendors Customer

Water Tank Analogy for Inventory

Supply RateInventory Level

Demand Rate

Inventory Level

MEANING• A physical resource that a firm holds in stock with the

intent of selling it or transforming it into a valuable state.

• Any stored resource used to satisfy a current or future need (Raw Materials, Work-in-process, finished goods, etc)

• Inventory is a list/record for goods and materials, held available in stock by a business

EFFECTS

• Represents as much as 50% of invested capitol at some companies.

• Excessive inventory levels are costly.

• Insufficient inventory levels lead to stock outs.

• Storage costs are high.

FIVE REASONS:• It enables the firm to achieve economies of scale• It balances supply and demand• It enables specialization in manufacturing• It provides protection from uncertainties in demand

and order cycle• It acts as a buffer between critical interfaces within

the channel of distribution

REASONS TO HOLD INVENTORY

• Inventory is required to realize the economies of scale in purchasing, transportation or manufacturing.

• Example: ordering large quantities of raw materials/ finished goods inventory allows the manufacturer to take advantage of the per unit price reductions associated with the volume purchases.

• Purchased materials have a lower transportation cost per unit if ordered in large volumes because less handling is required.

Economies of scale

• Seasonal supply or demand may make it necessary for a firm to hold inventory

• Example: Boxed Chocolate sales increase during Mother’s Day• Demand for a product may be relatively stable throughout the

year, but raw materials may be available only at certain times during the year (e.g. producer of canned fruits and vegetables) this makes necessary to manufacture finished products in excess of current demand and hold in inventory

Balancing Supply and Demand for Seasonal Inventories

• Inventory makes it possible for each of the firm’s plants to specialize in the products that it manufactures

• The finished product can be shipped to field warehouses where they are mixed to fill customer order

• The specialization by facility is known as Focused Factories

Specialization

• Inventory is held to prevent a stock-out in the case of variability in demand or variability in the replenishment cycle

• example: price increase, supply shortage and to maintain a source of supply

Protection from Uncertainties and Order Cycle

• Inventory is held throughout the supply chain to act as a buffer for the following critical interfaces:

1. Supplier – procurement (purchasing)2. Procurement – production3. Production – marketing4. Marketing – distribution5. Distribution – intermediary6. Intermediary – consumer/user

Inventory as a Buffer

REASONS TO REASONS TO NOTNOT HOLD INVENTORY HOLD INVENTORY

• Carrying cost– Financially calculable

• Takes up valuable factory space– Especially for in-process inventory

• Inventory covers up “problems” …– That are best exposed and solved

DANGERS OF OVER INVESTMENT

• Unnecessary tie-up of firm’s fund and loss of profit – involves opportunity cost

• Excessive carrying cost

• Risk of liquidity – difficult to convert to cash

• Physical deterioration of inventories while in storage due to mishandling and improper storage facilities.

DANGERS OF UNDER INVESTMENT

• Production hold-ups – loss of labor hours

• Failure to meet delivery commitments

• Customers may shift to competitors which will amount to a permanent loss to the firm

• May affect the goodwill and image of the firm

Inventory Hides Problems

Poor Quality

UnreliableSupplier

MachineBreakdownInefficient

Layout

BadDesign

LengthySetups

To Expose Problems:Reduce Inventory Levels

Poor Quality

UnreliableSupplier

MachineBreakdownInefficient

Layout

BadDesign

LengthySetups

Remove Sources of Problems and Repeat the Process

Poor Quality

UnreliableSupplier

MachineBreakdownInefficient

Layout

BadDesign

LengthySetups

Raw materials inventory

Supplier inventory

Work-in-process

inventory

Finished goods

inventory at plant location

Retail inventory

Reworking or repackaging of product

Waste and by

product

Waste disposal KEY: Forward logistics flow

Reverse logistics flow

The Logistics Flow

Reverse logistic move product backward through the channel for a number of reasonExample: a customer may return a product because it is damaged/ manufacturer may need to recall a product because of defects

Finished goods inventory at field

location

Consumer inventory

Cycle stock

• That results from replenishment of inventory sold or used

• It is required in order to meet demand under conditions of certainty; when the firm can predict demand and replenishment times (lead times)

• Example: if the rate of sales for a product is a constant 20 units per day and the lead time is always 10 days no inventory beyond the cycle stock would be required

TYPES

Basic inventory Principles – cycle stock

0 10 20 30 40 50 60

0 10 20 30 40 50 60

0 10 20 30 40 50 60

300

600

100

200

200

400Inventory Order

place

Order arrival

Orderplace

Order arrival

AverageCycleinventory

Days

B Order quantity of 200 units

Inventory Orderplace

Order arrival:

AverageCycleinventory

Days

C Order quantity of 600 units

Inventory

Orderplace

Order arrival:Next order placed

AverageCycleinventory

Days

A Order quantity of 400 units

Orderplace

In-transit Inventories• Items that are en route from one location to another• Considered part of cycle stock even though they are

not available for sale or shipment until after they arrive at the destination

• In-transit inventory should be considered as inventory at the place of arrival since the items are not available for use, sale or subsequent reshipment

Safety or Buffer Stock• Is held in excess of cycle stock because of uncertainty

in demand or lead time• Average inventory at a stock-keeping location is

equal to half the order quantity plus the safety stock

Average inventory investment under conditions of uncertainty

Inventory200

100

SafetyStock(50)

10

8

20Days

3040

AverageCycleinventory

Inventory200

100

SafetyStock(40)

121020Days

3040

AverageCycleinventory

B With variable lead time

Inventory200

100

SafetyStock(100)

121020Days

3040

AverageCycleinventory

C With variable demand and lead time

8

a With variable demand

10

Speculative Stock

• Is inventory held for reason other than satisfying current demand.

• Example: materials may be purchased in volumes larger than necessary in order to receive quantity discount, because of a forecasted price increase or materials shortage or to protect against the possibility of a strike.

Seasonal Stock

• Is a form of speculative stock that involves the accumulation of inventory before a seasonal period begins

• Example: agricultural product, fashion industry and seasonal items

Dead Stock

• Refers to items for which no demand has been registered for some specified period of time

• Might be obsolete throughout a company or only at one stock-keeping location

Inventory Planning and Control

For maintaining the right balance between high and low inventory to minimize cost

INVENTORY SYSTEM

• A set of policies and controls that :

– monitors levels of inventory and

– determines what levels should be maintained,

– when stock should be replenished, and

– how large orders should be maintained.

BENEFITS

• Ensure a continuous supply of raw materials and supplies to facilitate uninterrupted production.

• Maintain sufficient finished goods for smooth sales operation and efficient customer service.

• It permits the procurement of raw materials in economic lot sizes as well as processing of these raw materials into finished goods in the most economical quantities.

• It helps to reduce the material handling costs.

• It helps to utilize people and environment.

• Reduce dependencies of one another and enable the organizations to schedule its operations independently of another.

• It facilitates product display and service to customers.

• It enables management to make cost and consumption comparisons between operations and periods.

• It keeps the obsolescence losses, inventory carrying costs to the minimum.

• It provides a check against the loss of materials.

INVENTORY MANAGEMENT

It involves the development and administration of policies, systems and procedures which will minimize total costs relative to inventory decisions and related functions such as customer service requirements, production scheduling and purchasing.

• The key measure of effective inventory management is the impact that inventory has on corporate profitability

• Effective inventory management can improve profitability by lowering costs or supporting increased sale

• Better inventory management can increase the ability to control and predict how inventory investment will change in response to management policy

INVENTORY MANAGEMENT EFFECTIVENESS

Inventory Cost Structures

An optimum inventory level involves the following main types of costs:

• Ordering costs• Carrying (or holding) costs• Stock out costs• Capacity costs

• ORDERING COSTS – Quotation or Tendering– Requisitioning– Order placing– Transportation– Receiving, inspecting and storing– Quality control– Clerical and staff

• CARRYING COSTS– Warehousing or storage– Handling– Clerical and staff– Insurance– Interest– Deterioration, shrinkage, evaporation and obsolescence– Taxes– Cost of capital

• STOCK-OUT COSTS:– Loss of Sale

– Failure to meet delivery requirements

– Back ordering costs.

• CAPACITY COSTS:– Overtime payments when capacity is too small

– Layoffs and idle time when capacity is too large.

DECIDING ON THE INVENTORY MODEL

• Assume an analyst applies an inventory model that does not allow for spoilage to a grocery chain’s ordering policy for lettuce and formulates the strategy of ordering lettuce in large amounts every 14 days. A little thought will show that this is obliviously foolish. This strategy implies that lettuce will be spoiled. However it is not a failure of inventory, it is a failure to apply the correct model.

Inventory Management Inventory Management Systems/ModelsSystems/Models

• While managing inventory one must:

– Prioritize the items (ABC)

– Know how much to order (EOQ)

– Know when to order (ROP)

– Know to order (Continuous/Periodic)

– Know to track inventory (perpetual/physical)

(these are also known as Inventory Control Techiniques)

PRIORITIZATION TECHNIQUES

• Always better control (ABC) classification.• High, medium and low (HML) classification.• Vital essential and desirable (VED) classification.• Scarce difficulty and easy to obtain (SDE)• Fast moving, slow moving and non-moving (FSN)• GOLF classification• SOS classification

• ABC Analysis – inventories are classified on the basis of their consumption value.

• A – High value so, Low volume• B – Medium Value so, larger inventory level.• C – Low Value so, highest inventory level.

Also called Selective Control Inventory Method (SIM)

ABC Analysis

ABC Analysis• Recognizes that some inventory items are

more important than others

• A group items are considered critical (often about 70% of dollar value and 10% of items)

• B group items are important but not critical (often about 20% of dollar value and 20% of items)

• C group items are not as important (often about 10% of dollar value and 70% of items)

Silicon Chips Inc. Example

• Maker of super fast DRAM chips• Has 10 inventory items• Wants to classify them into A, B, and C groups• Calculate dollar value of each item and rank

items

Inventory Items for Silicon Chips

• A-items

– Track carefully (e.g. continuous review)

– Sophisticated forecasting to assure correct levels

• C-items

– Track less frequently (e.g. periodic review)

– Accept risks of too much or too little (depending on the item)

THEREFORE…….

HML Classification

• On the basis of unit value of item

• For e.g. there is 1000 unit of Q @ Rs.10 and 10000 units of W @ Rs.5

• Aimed to control the purchase of raw materials

H – High, M – Medium, L - Low

VED CLASSIFICATION

• Mainly for spare parts because their consumption pattern is different from raw materials.

• Classification is done on the basis of criticality of the item.

V – Vital, E – Essential, D - Desirable• Therefore V items has to be stocked more and D

items has to be less stocked.

FSN CLASSIFICATION

• According to the consumption pattern

• To combat obsolete items

F – Fast Moving, S – Slow Moving, N – Non Moving

SDF & GOLF CLASSIFICATION

• SDF:

• Based on source of procurement

S – Scarce, D – Difficult, E – Easy

• GOLF:

G – Government, O – Ordinary, L – Local, F - Foreign

SOS CLASSIFICATION

• Raw Materials especially for agriculture units

S – Seasonal, OS – Off Seasonal

ECONOMIC ORDER QUANTITY(EOQ)

Determining How Much to Order

• One of the oldest and most well known inventory control techniques

• Easy to use

• Based on a number of assumptions

• The best policy by minimizing the total of inventory carrying costs and ordering costs

• The EOQ is a concept which determines the optimal order quantity on the basis of ordering and carrying costs

• When incremental ordering costs equal incremental carrying costs, the most economic order quantity exists

Economic Order Quantity (EOQ)Model

THE BEST EOQ

EOQ recognizes the tug of war between acquisition costs and inventory carrying costs: when you order bigger quantities less frequently, your aggregate acquisition costs are low but your inventory costs are high due to higher inventory levels. Conversely, when you order smaller quantities more often, your inventory costs are low but your acquisition costs are higher because you are expending more resources on ordering. The EOQ is the order quantity that minimizes the sum of these two costs.

Economic Order Quantity (EOQ) (Assumptions)

• Demand is known and constant (AUU = annual usage in units)

• Ordering (setup) cost (ACPO = acquisition costs per order)

• Unit cost is constant (no quantity discounts) (UC)• Annual carrying costs on inventory value

(CCP = carrying cost percentage) • No stock outs.• Receipts of inventory is instantaneous.• Material is ordered or produced in a lot or batch.

FORMULA

EOQ =

2 x ACPO x AUU

UC x CCP

Where,

ACPO – Acquisition Costs Per Order

AUU – Annual Usage in Units

UC – Unit Cost

CCP – Carrying Cost Percentage

EOQ (Example#1)

• AUU = 4800 units• ACPU = Rs.40• UC = Rs.100 • CCP = 25%

WHAT IS THE EOQ?

EOQ (Example#1)

• AUU = 4800 units• ACPU = Rs.40• UC = Rs.100 • CCP = 25%

√ 2x40x4800

100 x 25%EOQ =

= 124 UNITS

DO IT YOURSELF…….

• It costs you $150 in overhead per order

• You use 5000 units a year

• Your finance department tells you that annual carrying costs are equal to 20% of the value of goods in stock.

• You pay $200 per unit

• You should order…………….?

DO IT YOURSELF…….

• It costs you $150 in overhead per order

• You use 5000 units a year

• Your finance department tells you that annual carrying costs are equal to 20% of the value of goods in stock.

• You pay $200 per unit

• You should order…………….?

194 units at a time

EOQ Inventory Order CycleEOQ Inventory Order Cycle

Demand rate

0 TimeLead time

Lead time

Order Placed

Order Placed

Order Received

Order Received

Inve

ntor

y L

evel

Reorder point, R

Order qty, Q

As Q increases, average inventory level increases, but number of orders placed decreases

ave = Q/2

REORDER POINTDetermining When to Order

• After Q* is determined, the second decision is when to order

• Orders must usually be placed before inventory reaches 0 due to order lead time

• Lead time is the time from placing the order until it is received

• The reorder point (ROP) depends on the lead time (L)

FORMULA (ROP)

ROP = SSQ + (QUD X ALT) (if safety stock is included)

Where,ROP = Reorder PointSSQ = Safety Stock QuantityQUD = Quantity used dailyALT = Average Lead Time (in days)

ROP(Example#1)

• Minimum Daily requirement – 800 units

• Time required to receive emergency supplies – 4 days

• Average daily requirement – 700 units

• Time required for refresh supplies – 30 days

• Calculate ordering point or re-order level.

ROP(Example#1)• Minimum Daily requirement – 800 units• Time required to receive emergency supplies – 4 days• Average daily requirement – 700 units• Time required for refresh supplies – 30 days• Calculate ordering point or re-order level.

Calculation:

ROP = 800 x 30

= 24000 units

ROP(Example#2)• Two types of materials are used.

• Minimum usage – 20 units per week each

• Maximum usage – 40 units per week each

• Normal usage – 60 units per week each

• Lead time;– Material A - 3 to 5 weeks– Material B - 2 to 4 weeks

• Calculate re-order point for both materials.

ROP(Example#2)• Two types of materials are used.• Minimum usage – 20 units per week each• Maximum usage – 40 units per week each• Normal usage – 60 units per week each• Lead time;

– Material A - 3 to 5 weeks– Material B - 2 to 4 weeks

• Calculate re-order point for both materials.Calculation:A: 60 x 5 = 300 unitsB: 60 x 4 = 240 units

‘Q’ SYSTEM vs ‘P’ SYSTEM

IT IS EMPLOYED BY THE ORGANIZATION WITHIN THE BASIC FRAMEWORK OF MODELS – FIXED ORDER QUANTITY SYSTEM or Q SYSTEMFIXED ORDER PERIOD SYSTEM or P SYSTEM

DISTINCTIONPoints of Diff Q system P System

Quantity of order Constant-the same quantity order each time

Quantity of order varies each time order is placed.

Size of Inventory Less than P System Larger than Q System

Time to maintain Higher Less time

Record keeping Continuous Only at the review period

Period of order Any time when stock levels reaches to reorder point

Only after predetermined period.

INVENTORY TRACKING METHODS

• PERPETUAL INVENTORY SYSTEM

• PHYSICAL INVENTORY SYSTEM

Perpetual Inventory System

A perpetual inventory system tracks the number of items in inventory on a constant basis. With this system, a business keeps track of sales as they occur.

In a manual system, employees gather paper records of sales and enter that information into the inventory system. Computer-based systems are faster and more accurate.

perpetual inventory system

An inventory system that tracks the number of items in inventory on a constant basis.

Physical Inventory System

In a physical inventory system , stock is visually inspected or actually counted to determine the quantity on hand. A company uses this system alongside perpetual inventory systems to:

• Determine the correct value of its ending inventory

• Identify stock shortages

• Plan future purchases

There are numerous methods for inventory control.

Physical Inventory System

The most popular method of inventory management is the physical inventory. These are usually wall-to-wall store inventories that require the business to close temporarily to conduct the inventory.

Cycle counts allow a business to physically count only a small portion of the inventory every day to track the entire inventory. The inventory is counted by a stock keeping unit (SKU) , which is a unit or a group of related items.

cycle counts

A small portion of the inventory is physically counted each day by stock keeping units so that the entire inventory is accounted for on a regular basis.

stock keeping unit (SKU)

A unit or a group of related items in a unit control inventory system; the smallest unit used in inventory control.

Physical Inventory System

Visual control is used mainly by smaller businesses. It uses stock cards noting the necessary number of each displayed item. The difference between the number on the card and the actual number of items on hand is the amount that needs to be reordered.

This system is somewhat inaccurate because it does not account for misplaced merchandise.

Cycle Counting of Inventory

Cycle counting uses inventory classifications developed by ABC analysis.That is:• Class A items are counted frequently, perhaps once a month.• Class B items are counted less frequently, perhaps once a quarter.• Class C items are counted perhaps once every six months.

Using Both Systems

Most businesses find it most effective to use both systems because they complement each other. The perpetual system gives an up-to-date inventory record throughout the year. The physical system gives an accurate count that can be compared to the perpetual records to identify errors or problems.

Using Both Systems

When the physical count shows less merchandise than is supposed to be in inventory, a stock shortage or shrinkage has occurred. Possible reasons are:

• Employee and customer theft

• Receiving errors

• Incorrect counting

• Selling errors

Stock Control

Stock control involves monitoring stock levels and investments in stock so that a business is run efficiently. It includes:

• Dollar versus unit control methods

• Inventory turnover calculations

Using Both Systems

Dollar control represents the planning and monitoring of the total inventory investment that a business makes during a stated period of time. It helps a business determine the cost of goods sold and the amount of gross profit or loss during a given period of time.

dollar control

The planning and monitoring of the total inventory investment that a business makes during a stated period of time.

Using Both Systems

Unit control measures the quantities of merchandise that a business handles during a stated period of time. It allows purchasing personnel to see what brands, sizes, colors, and price ranges are popular.

unit control

The quantities of merchandise that a business handles during a stated period of time.

Using Both Systems

Inventory turnover is the number of times the average inventory has been sold and replaced in a given period of time. It is the most effective way to measure how well inventory is being managed.

The higher the inventory turnover rate, the more times the goods were sold and replaced. Stores that keep records of the retail value of stock compute their inventory turnover rates as follows:

_______Net sales (in retail dollars)________

Average inventory on hand (in retail dollars)

inventory turnover

The number of times the average inventory has been sold and replaced in a given period of time.

Using Both Systems

When only cost information about inventory is available, inventory turnover can be calculated with this formula:

_______Cost of goods sold________

Average inventory on hand (at cost)

Using Both Systems

When a store wants to look at the number of items carried in relation to the number of items sold, it calculates its stock turnover rates in units with this formula:

_______Number of SKUs sold________

Average SKUs on hand

MerchandiseAvailable

for Sale

Net Costof Purchases

Cost ofGoods Sold

BeginningInventory

EndingInventory

INVENTORY COST FLOWS

IMPORTANCE OF INVENTORY VALUATION

• Costing method has important effect on net income and asset valuation.

BeginningInv.

+ Inv.Purchase

= Goods Available for Sale

Ending Inv. Cost of Goods Sold

Needs to be allocatedWeighted Average

LIFOFIFO

Costing method

BASIC ASSUMPTIONS• FIFO (first-in, first-out): Units sold are

assumed to be first units purchased (ending inventory = costs of the last purchases)

• LIFO (last-in, first-out): Units sold are assumed to be last units purchased (ending inventory = cost of the first units purchased)

• Average (periodic): Unit cost = (cost of beginning inventory + cost of purchases) divided by the total units involved; thus, ending inventory = unit cost x units on hand!

AS A RESULT……..• FIFO: Ending inventory is costed using nearest-to-

year-end replacement costs.– Old (lower) costs were matched to sales, which produces a

“higher” reported gross profit.

• LIFO: Ending inventory is costed using nearest-to-year-start (oldest) costs.– New (higher) costs were matched to sales, which produces

a “lower” reported gross profit.

(Opposite results are reported during deflationary times)

Comparative Results During Inflation(1) In a period of rising prices, LIFO has the smallest

ending inventory and FIFO the largest.

(2) In a period of rising prices, LIFO has the largest cost of goods sold and FIFO the smallest.

(3) In a period of rising prices, FIFO has the largest gross profit and LIFO has the smallest.

When a unit is sold, the average cost of each

unit in inventory is assigned to cost of

goods sold.

When a unit is sold, the average cost of each

unit in inventory is assigned to cost of

goods sold.

Cost of Goods

Available for Sale

Units available on the date of

sale

÷

Average Cost

Use of Inventory Methods in Practice

Inventory Costing Method

Example # 1

• Facts:a. Retailer started the year with a beginning inventory of one refrigerator that cost $300.b. The retailer purchases another identical refrigerator for a cost of $340 during the year.c. At the end of the year, the retailer sells one of the refrigerators for $500.2. The total cost of goods available for sale equals beginning inventory plus purchases ($640 in this example).

Example # 1 (Cont’d)

– The first-in, first-out (FIFO) method of inventory costing method assumes that the first unit purchased is the first unit sold. Therefore, cost of goods sold in this example is $300.

– The last-in, first-out (LIFO) method of inventory costing method assumes that the last unit purchased is the first unit sold. Therefore, cost of goods sold in this example is $340.

Example # 1 (Cont’d)

FIFO LIFO Average

Sales Revenue $ 500 $ 500 $ 500

COGS $ 300 $ 340 $ 320

Operating Profit $ 200 $ 160 $ 180

Ending Value $ 340 $ 300 $ 320

Example 2• Facts: C & Co. had beginning inventory of 14,000

units purchased at $6 per unit, for a total opening cost of $84,000.

• ANNUAL INVENTORY ACTIVITY FOLLOWS:

Purchases Units Unit Cost Total Cost

January 10 10,000 $7.00 $ 70,000

June 15 15,000 $8.00 $120,000

December 1 8,000 $8.50 $ 68,000

Total 33,000 $258,000

Example 2 – Contd.

Sales Units Sales Price Total Sales

February 15 7,000 $15.00 $105,000

May 1 5,000 $16.00 $ 80,000

October 1 11,000 $17.00 $187,000

December 15 15,000 $18.00 $270,000

Total 38,000 $642,000

Calculate ending inventory, cost of goods sold and gross profit under three periodic methods: LIFO, FIFO and Average.

Cost of Good Available for Sale?• Solution:

– 47,000 units were available during the period (14,000 beginning inventory +

33,000 purchased)– 38,000 units were sold– 9,000 units were in ending inventory

• Cost of goods available for sale = $84,000 of beginning inventory + purchases of $ 258,000 = $ 342,000.

Example 2 – Contd.

LIFO Assumption• Ending Inventory = $54,000

The cost of the first 9,000 units purchased: 9,000 beginning inventory × $6

• Cost of Goods Sold = $288,000 Details: (8,000 × $8.50) + ($15,000 × $8) +

(10,000 × $7) + (5,000 × $6)

• Check: $54,000 + $288,000 = $342,000, the cost of goods available for sale

Example 2 – Contd.

FIFO Assumption• Ending Inventory = $76,000

The cost of the last 9,000 units purchased: (8,000 × $8.50) + (1,000 × $8)

• Cost of Goods Sold = $266,000Details: (14,000 × $6) + (10,000 × $7) +

(14,000 × $8)

• Check: $76,000 + $266,000 = $342,000, the cost of goods available for sale

Example 2 – Contd.

Periodic Averaging• Average Cost = $7.2766

$342,000 cost of goods available for sale 47,000 units available for sale

• Ending Inventory = $65,4899,000 units × $7.2766

• Cost of Goods Sold = $276,51138,000 units × $7.2766

• Check: $65,489 + $276,511 = $342,000, the cost of goods available for sale

Example 2 – Contd.

Comparative Results During InflationLIFO FIFO Average

Balance Sheet

Ending Inventory (1) 54,000 76,000 65,489

Income Statement

Sales 642,000 642,000 642,000

CGS (2) 288,000 266,000 276,511

Gross Profit (3) $354,000 $376,000 $365,489

Example 2 – Contd.