The Mathematics of Money

596 Chapter 15 Payroll and Inventory

The overall value of the inventory is therefore:

Inventory value 
 $357.50  $1,278  $750 
 $2,385.50

In summary:

Inventory Valuation by LIFO:

The value of the inventory of a given item is found as follows:

1. Make a list of previous purchases’ quantity and cost.


2. Assume that sales came fi rst from the newest lot, and move backward until all
   sales are accounted for.


3. The inventory value is the cost of the remaining items.

The use of LIFO presents some logical problems. With the average cost method and with

FIFO we did not claim that we really knew which lots the sold light bulbs came from, but

the assumptions that underlay both of those methods seem pretty reasonable. With LIFO,

though, we are assuming that the 925 sold bulbs came from the third order, even though we

know for a fact that those could not possibly have been the actual bulbs sold. This is not

necessarily a problem, since any of these methods are based on hypothetical assumptions.

Still, the hypothetical assumptions for average cost and FIFO seem far more reasonable.

Despite this, LIFO is very commonly used in the United States; Exercise 28 may offer a

hint as to why a business might prefer this method.

Perpetual versus Periodic Inventory Valuation

In all of our discussion and in all of our examples so far, we have assumed that a company

will revalue its inventory of an item every time a new purchase of that type of item is made.

This approach to inventory valuation called perpetual. An alternative approach would be to

place a value on the company’s inventory only when the company actually does its books,

typically at the end of each quarter. This approach is called periodic.

The timing of when we value inventory might not seem to be much of a mathematical

issue. However, it can make a difference in the value that actually is placed on the inven-

tory. It will be easiest to see this by means of an example.

Suppose we are doing inventory for an office supply store. During the first quarter of the

year, the company received one shipment of copier paper. The history of the store’s inven-

tory during the first quarter is shown in the table below:

Lot

Number of

Boxes

Va lue

(at Cost)

Boxes Sold before

Next Order

Beginning Inventory 217 $3,742 130

Shipment 1 80 $1,278 92

Suppose we set out to determine the inventory value as of the end of the quarter, using the

perpetual average cost method (the way we did in Examples 15.1.1 and 15.1.2).

Right before the first shipment arrived, the store had an inventory of 217  130 
 87

boxes of paper. We would value these at:

(^)
21787  $3,742
$1,500.25
With the new shipment, the store’s inventory increases to 87  80
167 boxes, and the
value of this inventory would be $1,500.25  $1,278
$2,778.25.
At the end of the quarter, the store would be left with 167  92
75 boxes. We would
value these at:
(^)
16775  $2,778.25
$1,247.72