Written by Zachary Kremian, Supply Times
In order to remain competitive, companies across industries have increased their emphasis on inventory valuation. In easy-speak, companies can no longer afford lax oversight over inventory assets – raw materials, parts, components, produced goods, etc. – and have shifted a bulk of time, resources and revenues to developing precise inventory accounting systems.
Although many companies have turned to perpetual inventory systems for real-time visibility of current inventory values, periodic inventory systems are still a mainstay for many companies in manufacturing, logistics and fulfillment – or at least remain a component of the inventory valuation process.
For businesses using a periodic inventory accounting system, only revenues are updated after a sale – and not actual inventory value. In periodic systems, on the other hand, a regularly scheduled physical inventory check is required to gain total visibility of inventory assets and value.
Therefore, if a periodic system is in place, it’s critical for manufacturers to grasp the three major costing methods, when they should be applied, and how they may affect cost flow:
First in first out (FIFO)
Defined: The oldest inventory asset is recorded as sold first – regardless of the actual shelf age of the given physical asset.
Applied: While it is the most widely used accounting technique in periodic inventory management today, FIFO may fail to offer a full picture of inventory value if inflation and price increases are not closely analyzed. Thus, FIFO may inflate or deflate the actual value of future inventory.
Last in first out (LIFO)
Defined: The newest inventory asset is recorded as sold first.
Applied: The LIFO method could reduce a company’s tax responsibility in times of growing inflation – but it has been heavily regulated under the International Financial Reporting Standards.
Average cost or weighted cost (AVCO)
Defined: The AVCO (average cost) method will take the total cost of goods still available for sale and divide it by the total sum of product from the beginning inventory and purchases.
Applied: With the AVCO method, cost flow is determined as a weighted average of all total unit costs.