Copyright © 2008, The McGraw-Hill Companies, Inc.
So, using the perpetual average cost method those 75 boxes have a value of $1,247.72.
Now, let’s consider the periodic average cost method. Rather than recalculate the inven-
tory’s value after each new order, we just consider where things stand at the end of the quarter.
Over the course of the entire quarter, there were 217 80 297 boxes of this copier paper
that the store had in its inventory at some point. The total cost of these boxes was $3,742
$1,278 $5,020. The store sold 130 92 222 boxes, leaving 297 222 75 boxes in
inventory at quarter’s end. The value we would then place on the 75 boxes would be:(^) ____ 29775 $5,020 $1,267.68
Notice that the periodic approach gives a different inventory value than the perpetual
approach. Which one is correct? In fact, either one could be considered the correct value
for the company’s copier paper inventory. As we have seen throughout this section, the
value placed on inventory depends on the method used, and there is no single method that
must be used in every situation. If the company uses perpetual valuation, the correct answer
is $1,247.72; if the company uses periodic valuation, the correct value is $1,267.68.
Historically, periodic valuation has been by far the more commonly used method. The
reason for this, though, has mainly been a matter of convenience. With perpetual valuation,
a business needs to recalculate its inventory value whenever a new shipment arrives, and
must know precisely the number of items it has in stock when the new order arrives. If
doing this requires counting boxes in the warehouse and by-hand calculation and recording
the perpetual approach is, frankly, more trouble than its worth.
Today, though, most businesses keep track of their purchases and sales, track their inven-
tory, and even do their books electronically. Determining our office supply store’s copier
paper inventory more likely involves a trip to the computer than a trip to the warehouse,
and the inventory valuation is likely to be done automatically by the store’s electronic
bookkeeping system. The use of technology robs periodic valuation of much of its appeal,
and as a result businesses are increasingly using the perpetual approach.
For this reason, in this section we have focused on the perpetual approach, and except where
specifically noted otherwise all of the exercises for this section should be done in that way.
We have used the average cost method to consider the difference between perpetual and
periodic valuation. What if we used FIFO or LIFO instead? With FIFO it makes no differ-
ence whether inventory is valued periodically or perpetually. With LIFO, though, the two
approaches may lead to differing results, just as they did with average cost.
Calculating Cost of Goods Sold Based on Inventory
A business must periodically determine its profits (or losses); most businesses do this quar-
terly, or at least annually. When calculating the business’s profit or loss, one component of
that calculation must be the cost of the merchandise that was sold during the period.
Regardless of the method used to value inventory, we can use the at-cost value of the
inventory to determine this. Suppose that your business began the quarter with inventory
that had a cost of $15,000 and during the quarter you purchased additional inventory at a
cost of $35,000. This brings the total at-cost value of all inventory you had during the quar-
ter up to a total of $50,000. Naturally, you sold some of this merchandise, and at quarter’s
end you had inventory valued at a cost of $20,000.
What was the cost of the merchandise that you sold? A moment’s thought reveals that,
if $20,000 remained from a $50,000 total, the cost of the goods sold must be $30,000. In
other words, we can calculate the cost of goods sold in a given period by:
Cost of goods sold Starting inventory Purchases Ending inventory
Example 15.2.5 Suppose that the Plum Street Pharmacy began the third
quarter with inventory valued at $545,636. The pharmacy made purchases totaling
$1,275,936, and its end-of-quarter inventory was $659,800. Calculate the cost of
goods sold in the third quarter.
15.2 Inventory 597