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The Corporate Finance Institute Accounting
Inventory and COGS
Ending inventory is also determined by the accounting method for
Cost of Goods Sold. There are four main methods, namely FIFO, LIFO,
Weighted-Average and Specific Identification. These all have certain
criteria to be applied, and are prohibited under certain accounting
standards, but all of them also vary in the value of cost of goods sold.
In an inflationary period, LIFO will generate higher Cost of Goods Sold
than the FIFO method. As such, using the LIFO method would generate
a lower inventory balance than the FIFO method. This must be kept in
mind when an analyst is analyzing this account.
Periodic and Perpetual Inventory Systems
A perpetual inventory system is one that directly keeps track of
additions to and withdrawals from inventory. With this inventory
system, an organization can determine the inventory quantity on hand
and the cost of goods sold from its accounting records at any point in
time. With more technology being implemented by companies, this
method continues to increase in popularity because it can produce
more information, at quicker rate. Even if a perpetual inventory system
is used, organizations still need to conduct an inventory count because
perpetual records may not always be correct. A periodic inventory
system, on the other hand, does not keep a continuing record of
inventory and cost of goods sold. On the financial statement date,
the organization will conduct an inventory count to determine the
ending inventory quantity. Using the values of beginning inventory and
purchases, these values can be plugged into the inventory equation to
calculate for COGS.
Related Metrics
The average inventory balance between two periods is needed to
find inventory turnover. This is also needed to determine inventory
turnover days. In these calculations, either net sales or cost of goods
sold can be used as the numerator, although the latter is generally
preferred as it is a more direct representation of the value of inventory.
Accounts payable turnover requires the value for purchases as the
numerator. This is indirectly linked to the inventory account, as
purchases affect inventory as well.
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