What is inventory? Perpetual inventory method & periodic inventory? Methods of calculating inventory cost such as first in first out & last in first out?
I. Legal basis
Accounting standard No. 02 on inventories issued in Decision 149/2001/QD-BTC dated December 31, 2001.
II. What is inventory? What does inventory include?
1. What is inventory?
Inventories are assets stored for sale during the normal production and business period; goods in the process of production and business; raw materials, tools and equipment used in the production and business process or in providing services.
2. What does inventory include?
Inventory includes:
- Goods purchased for sale: inventory, purchased goods in transit, goods sent for sale, goods sent for processing;
- Finished product;
- Work in progress, including unfinished products and finished products that have not been put into finished goods warehouse. If the production and circulation time of unfinished products exceeds 1 normal business cycle, they will not be recorded as inventory in the balance sheet but presented as long-term assets;
- Raw materials, tools, and equipment in stock, sent for processing or purchased and in transit;
- Work in progress.
III. Inventory accounting methods
| Method | Regular reporting method |
| Concept | It is a method of regularly, continuously and systematically monitoring and reflecting the situation of import, export, and inventory of materials, raw materials and goods during the period into the accounting system. |
| Advantage | Helps businesses control inventory at all times; minimizes errors; and meets many urgent needs in production and business activities. |
| Disadvantages | Increase workload, inventory, daily recording of goods. |
| Apply | Manufacturing, industrial, construction companies and companies trading in items such as machinery, equipment, technical goods, high quality and high value. |
| Method | Periodic inventory method |
| Concept | This method only reflects the beginning and ending inventory, not the imports and exports during the period (*) |
| Advantage | Simple, streamlined accounting work. |
| Disadvantages | No regular control of inventory, no flexibility; few errors can be detected; accounting and reporting work is concentrated at the end of the period. |
| Apply | Companies have many types of goods and materials with very different specifications and designs, low value, goods and materials are used or sold in large quantities and continuously (retail stores…). |
(*):
| Value of goods sold during the period | = | Beginning inventory value | + | Value of goods imported into inventory during the period | – | Ending inventory value |
IV. Methods of calculating the cost of inventory
According to accounting standard No. 02 – Inventories issued in Decision 149/2001/QD-BTC dated December 31, 2001 of the Ministry of Finance, there are 4 methods to calculate inventory value. Therefore, depending on the type of enterprise, choose 1 of the 4 methods to determine inventory value as follows:
1. Method of calculating inventory value by specific cost
The specific price method is applied based on the actual value of each type of purchased goods and each type of manufactured product, so it is only applicable to businesses with few product codes or stable and identifiable goods.
➨ Advantages :
Comply with the matching principle of accounting, actual costs and actual revenue are consistent with each other, inventory value is correctly reflected according to its actual value;
➨ Disadvantages :
Applying this method requires strict conditions; only businesses that trade in a small number of product types, have high-value inventories, and have stable and identifiable products can apply this method.
For example:
fdiinvietnam.com LLC has the following business transactions:
– Beginning inventory: Raw materials X 10,000kg, unit price 5,000 VND/kg;
– January 5, 2021: Import 7,000 kg of raw material X, unit price 5,200 VND/kg;
– January 15, 2021: Export 7,000 kg of raw material X;
– January 25, 2021: Exported 8,000 kg of raw material X.
➥ Like that:
– Warehouse value on January 15 = 7,000 x 5,200 = 36,400,000;
– Warehouse value on January 25 = 8,000 x 5,000 = 40,000,000.
2. Weighted average method
Under this method, the value of each inventory item is calculated based on the average value of each inventory item at the beginning of the period and the value of each inventory item purchased or produced during the period. The average value can be calculated periodically or after each imported shipment, depending on the specific conditions of each enterprise.
2.1 Average weighted balance at the end of the period
According to this method, the cost of goods is calculated at the end of the period for each time the goods are released from the warehouse during the period. Depending on the storage period applied by the enterprise, the accountant will base on the import price, the value of the inventory at the beginning of the period and the import during the period to calculate the average unit price. Below is the calculation formula:
| Average end-of-period warehouse price of each item code | = | ∑ (Value of inventory at the beginning of the period + Value of goods imported during the period) | |
| ∑ (Quantity of goods in stock at the beginning of the period + Quantity of goods imported during the period) |
➨ Advantages :
Simple, compact, only need to calculate once at the end of the period;
➨ Disadvantages :
Low accuracy, work piled up at the end of the period affects other accounting work and does not provide timely accounting information at the time of occurrence.
For example:
fdiinvietnam.com LLC has the following business transactions:
– Beginning inventory: Raw materials X 10,000kg, unit price 5,000 VND/kg;
– January 5, 2021: Import 5,000 kg of raw material X, unit price 5,200 VND/kg;
– January 15, 2021: Import 15,000 kg of raw materials X unit price 5,500 VND/kg;
– January 25, 2021: Exported 18,000 kg of raw material X.
➥ Like that:
– Unit price of raw material X calculated by weighted average method at the end of the period:
| Average ending inventory unit price of raw material X | = | (10.000 x 5.000 + 5.000 x 5.200 + 15.000 x 5.500) |
| (10.000 + 5.000 + 15.000) | ||
| = | 5,283 VND. |
– Value of raw materials X on January 25 using the average method at the end of the period
= 5.283 x 18.000 = 95.094.000.
2.2 Instantaneous weighted average (continuous weighted average)
According to the moving average method, after importing products, materials, and goods, the accountant must re-determine the actual value of the inventory and the average unit price of that item code. The formula is as follows:
| nth warehouse delivery price | = | ∑ (Value of opening inventory + Value of imported goods before the nth export) | |
| ∑ (Quantity of goods in stock at the beginning of the period + Quantity of goods imported before the nth export) |
➨ Advantages : This method overcomes the disadvantages of the average method at the end of the period, is both accurate and can be updated continuously;
➨ Disadvantages : This method is laborious and requires multiple calculations. Therefore, this method is applied to businesses with few inventory codes and few import and export activities.
For example:
fdiinvietnam.com LLC has the following business transactions:
– Beginning inventory: Raw materials X 10,000kg, unit price 5,000 VND/kg;
– January 50, 2021: Import 5,000 kg of raw material X, unit price 4,800 VND/kg;
– January 10, 2021: Export 12,000kg of raw material X;
– January 15, 2021: Import 15,000 kg of raw materials X unit price 5,500 VND/kg;
– January 25, 2021: Exported 12,000 kg of raw material X.
➥ Like that:
– The unit price of raw material X is calculated using the instantaneous weighted average method:
| Unit price of raw material X on January 10 | = | (10.000 x 5.000 + 5.000 x 4.800) |
| (10.000 + 5.000) | ||
| = | 4,933 VND. |
– Value of raw materials X on January 10 = 4,933 x 12,000 = 59,200,000.
| Unit price of raw material X on January 25 | = | (3000 x 4.933 + 15.000 x 5.500) |
| (15.000 + 3.000) | ||
| = | 5,405 VND |
– Value of raw materials X on January 25 = 5,405 x 12,000 = 64,866,000.
3. First in, first out method (FIFO method)
The first-in, first-out method is based on the assumption that the value of inventory that is purchased or produced first is sold first and the value of goods issued is calculated based on the price of the first batch of goods purchased or produced first and carried out in turn until they are all sold.
➨ Advantages :
The cost of goods sold can be calculated immediately each time the goods are sold, thus ensuring timely data provision for accounting to record the parts as well as for management. The cost of goods sold will be relatively close to the market price of that item. Therefore, the inventory index on the accounting report reflects the actual value more.
➨ Disadvantages :
According to this method, current revenue is generated based on the value of existing products, materials, and goods, so it is not suitable for the current cost of these products, materials, and goods.
For example: fdiinvietnam.com LLC has the following business transactions:
– Beginning inventory: Raw materials X 10,000kg, unit price 5,000 VND/kg;
– January 5, 2021: Import 5,000 kg of raw material X, unit price 5,200 VND/kg;
– January 15, 2021: Import 15,000 kg of raw material X, unit price 5,500 VND/kg;
– January 25, 2021: Exported 18,000 kg of raw material X.
➥ Value of raw materials X on January 25 using FIFO method
= 10.000 x 5.000 + 5.000 x 5.200 + 3.000 x 5.500
= 92.500.000.
4. Last in, first out method (LIFO method)
The method is based on the assumption that the inventory purchased or produced later is sold first, and the remaining inventory at the end of the period is the inventory purchased or produced earlier. According to this method, the value of goods sold is calculated based on the price of the last imported shipment, and the value of inventory is calculated based on the price of goods imported at the beginning of the period.
➨ Advantages :
The cost of goods sold can be calculated immediately after each sale, thus ensuring timely data provision for accountants to record the sales as well as for management. The cost of the most recent purchase is close to the actual cost of goods sold, complying with the matching principle of accounting.
➨ Disadvantages :
The cost of inventory remaining at the end of the period does not match reality.
For example: fdiinvietnam.com Company Limited, has the following business transactions:
– Beginning inventory: Raw materials X 10,000kg, unit price 5,000 VND/kg;
– January 5, 2021: Import 5,000 kg of raw material X, unit price 5,200 VND/kg;
– January 15, 2021: Import 15,000 kg of raw material X, unit price 5,500 VND/kg;
– January 25, 2021: Exported 18,000 kg of raw material X.
➥ Value of raw materials X on January 25 using LIFO method
= 15.000 x 5.500 + 3.000 x 5.200
= 98.100.000.
>> See more: Notes when preparing financial statements for inventory items.
V. Frequently asked questions about inventory valuation
1. Which types of business do inventory valuation methods apply to?
- Weighted average method: Applicable to businesses with few types of inventory and few imports and exports;
- Specific method: Applicable to businesses with few items, large value items, and stable items;
- Calculating the cost of goods sold using the FIFO method: Usually applied to businesses trading in cosmetics and medicine.
2. Among the methods of calculating inventory cost, which method is most commonly used by businesses today?
For inventory accounting standards, there are 04 methods of calculating cost of goods sold. However, most businesses today choose the weighted average method to apply to calculate cost of goods sold and track inventory for businesses because the advantage is simple, easy to implement and only needs to be done at the end of each period.