Question

Why is it important to periodically take a physical inventory when using a perpetual inventory system? Briefly explain the FIFO, LIFO, and Weighted Average methods of valuing inventory.

Answer 1

It is important to take a physical inventory on every issue of goods to keep the inventory updated and cost of every goods sold is transfered from inventory to COGS.

To ensure the accuracy of the perpetual inventory system, physical counts of the inventory are done a few times in a year. This helps us cross-check the inventory and check the accuracy and validity of the perpetual inventory system.

Four methods

Weighted average method: To use the weighted average model, one divides the cost of the goods that are available for sale by the number of those units still on the shelf. This calculation yields the weighted average cost per unit—a figure that can then be used to assign a cost to both ending inventory and the cost of goods sold.

FIFO: Under FIFO, the oldest cost of an item in an inventory will be removed first when one of those items is sold. This oldest cost will then be reported on the income statement as part of the cost of goods sold.

LIFO: The LIFO accounting method assumes that the latest items bought are the first items to be sold. With this accounting technique, the costs of the oldest products will be reported as inventory. It should be understood that, although LIFO matches the most recent costs with sales on the income statement, the flow of costs does not necessarily have to match the flow of the physical units.