Handling Inventory Price changes

The way inventory is costed and how it physically flows doesn't need to be the same.

There are several different methods of accounting for inventory, each appropriate in certain situations but not in others. There are very few circumstances in which your previous method ("replacement cost") would be acceptable.

The accountant has proposed "FIFO" (First In, First Out) which is one of the most common methods. If you've never heard of it, your experience with inventory accounting must be very limited.

Another common method is Average Cost. You might find that easier to implement than FIFO. Ask your accountant about it.

In practice, the method used will have a significant impact only when costs change significantly in a consistent direction over an extended period AND your inventory turns over more slowly than the pace of cost changes. Ask your accountant about that, too; maybe analysis of your inventory would show that it won't really matter what method of inventory accounting you use.

changed the

associated price)

individually

Well, I'm familiar with term FIFO, but no... I'm not an accountant. Thank you for the information, Al Camp

As others have indicated, your accountant is talking about FIFO accounting. The reason behind this is:

4 of #123 @ $1.00 = $4.00 6 of #123 @ $1.25 = $7.50 =========================10 of #123 $11.50

If you just change all of #123 to $1.25, that gives you $12.50 in inventory, which is wrong. You're overstating your inventory balance, and then when you sell the buggers off at make an entry for Cost of Goods Sold, you're overstating that, too.

For FIFO, think of a conveyer belt: the first items you purchase (FI -- First In) are the first ones that roll off the belt, and are sold to the customer (FO - First Out). If prices are rising, this means the less expensive parts are sold first.

For LIFO, think of a pile of hay: the last items you purchase (LI -- Last In) are the first ones that are picked up, because they are on the top of the pile, and the first ones sold to customers (FO -- First Out). If prices are rising, this means the more expensive parts are sold first.

There's also individual unit costing, which is generally only used for large ticket items (think: yachts), and average costing, which is just what it describes: an average of inventory on hand... it requires adjusting.

While it may be tempting, do not switch back and forth between LIFO and FIFO, just to improve a bottom line. That'll get you a bit more than just a wrist-slap, if it's caught.

Does this make sense? Certain inventory types are more accurately represented by certain inventory methods.

-Holly

Thanks very much for that really good info.

My problem now is to figure out how I can develop the application to Recv and Disb using the LIFO model. At first blush, the easiest way to do that (from my database application side) is to log each part as it comes in with own price info and a unique identifier for each part received, and... Disburse each part the same way. Like my example, a checkbook program that tracks each dollar SerialNo In and Out. A thirty dollar deposit would require 30 entries in the checkbook.

But... that would be impossible for the client!

So, I'm leaning towards a "batch" concept. 50 parts recvd on such and such a date, and disbursement would reduce that batch amount until that batch was depleted... then on the the next latest batch date.

But... that's my problem, not an accounting problem...

Again, thanks for the useful info,

You're welcome!

Impossible and unneccesary :) There are inventory management programs out there. Why reinvent the wheel?

Ding ding ding! Not sure how widely-used the term is, but in Intermediate Accounting, it was called "layers" -- burn through the most-recent price layer first (for LIFO), as your inventory goes out the door, then on to the next-most recent, etc., until your order is fulfilled. Looks like you've got the idea, though.

Yup. Now that the accounting concept is cleared up, it's just a logistics/programming one. Easy enough with a database server is to create a table which tracks quantity, price and date of inventory purchased, and then when you need to expense it (remove it from the inventory-on-hand table), sort by date, and start ticking down the quantity while summing the cost, until you have removed the number of items required for that transaction/sale -- then you'll have the COGS for that entry. Get it?

-Holly

Holly, Thanks again! Just one quick question... I mentioned that these "parts" are not for sale. They are for the repair and maintenance of the clients own production machinery (in this case looms). I take it that doesn't make any difference in how they account for it? "COG is COG is COG...?"

By the by... the inventory system I built for them for the fabric they "sell" does track the price of each roll, and the date it was placed in inventory, so they could LIFO or FIFO that very easily.

Thanks for taking some time to help me get going in the right direction. I volunteer on the MSAccess database newsgroups. Perhaps someday, I can return the favor...

I didn't pay attention to the use of the parts. Presumably they are charged to Repair/Maintenance Expense, not COGS, however the discussions about methods of tracking the costs are still applicable.

LIFO, by the way, is used only in certain very specific circumstances and is otherwise not considered an acceptable method.

programs out

until that

Intermediate

purchased, and

inventory-on-hand

Hmmm... I think the client mentioned something about Last in First Out. Ill be meeting with them this morning. Thanks for that heads up... As I say... I'm a programmer not an acountant, so I'm caught in the middle a bit on this. But, what the customer wants... the customer gets. Thanks again for your help.

Based on what you've said in this and follow up posts, I would consider an averaging method for the software, and let the FIFO/LIFO, etc. be handled by the accountants.

So if you had 4 on hand at $1 each, and purchased 4 at $1.5, show 8 at $1.25 and be done with it.

Bill, Couldn't agree more! I discussed this with the client today, and I think I have them convinced to go with Cost Averaging. I would only have to add some recalculation of the "master" price in Receiving as new parts arrive at new prices. Disbursement would not need to be changed at all. FIFO would require a complete and difficult rebuild of the current inventory system. I would be more apt to give FIFO a go if we were building the inventory system for the first time.

Thanks, Al Camp

Excellent! Sounds like you found the "best" way to go about it for the client. Parts shops tend to use average as well, because the parts are pretty much indistinguishable and not really subject to great price fluctuations... everything's pretty much the same (or "average" if you will :)

Hopefully you learned a little accounting, too.

-Holly