Chapter 6 Inventories 271INVENTORY COSTING METHODS UNDER
A PERPETUAL INVENTORY SYSTEMIn a perpetual inventory system, all merchandise increases and decreases are recorded
in a manner similar to recording increases and decreases in cash. The merchandise in-
ventory account at the beginning of an accounting period indicates the merchandise in
stock on that date. Purchases are recorded by debiting Merchandise Inventoryand cred-
itingCashorAccounts Payable. On the date of each sale, the cost of the merchandise
sold is recorded by debiting Cost of Merchandise Soldand crediting Merchandise Inventory.
As we illustrated in the preceding section, a cost flow must be assumed when iden-
tical units of an item are purchased at different unit costs during a period. In such
cases, the fifo, lifo, or average cost method is used. We illustrate each of these methods,
using the data for Item 127B, shown below.Item 127B Units Cost
Jan. 1 Inventory 10 $20
4 Sale 7
10 Purchase 8 21
22 Sale 4
28 Sale 2
30 Purchase 10 22First-In, First-Out Method
Most businesses dispose of goods in the order in which the goods are purchased. This
would be especially true of perishables and goods whose styles or models often change.
For example, grocery stores shelve their milk products by expiration dates. Likewise,
men’s and women’s clothing stores display clothes by season. At the end of a season,
they often have sales to clear their stores of off-season or out-of-style clothing. Thus,
the fifo method is often consistent with the physical flowor movement of merchandise.Exhibit 4
Inventory Costing
Methods*Number of firms (> $1B Sales)0100200300400500600Fifo Lifo Average
cost
Source:Derived from Disclosure financial database.
*Firms may be counted more than once for using multiple methods.Determine the cost of in-
ventory under the perpet-
ual inventory system, using
the first-in, first-out; last-in,
first-out; and average cost
methods.