Cost recognized as expenses

  • Period cost 
  • Costs that are expensed in the period incurred
  • Including 
    • Abnormal waste of materials, labor, overhead 
    • Storage costs
    • Administrative overhead
    • Selling costs


  • Rebate
    • An amount paid by way of reduction, return, or refund on what has already been paid or contributed.
  • Trade discounts
    • discount which is referred to as, discount given by the seller to the buyer at the time of purchase of goods

Some assumptions and precondition

  • Cost of purchasing or producing inventory will change over time
  • The firm must employ the same cost flow method for inventories

Cost flow methods (2-1) to allocate inventory cost to income statement and balance sheet

  • Specific identification (3)
    • Each unit sold is matched with unit actual cost
  • First in, first out  (4)
    • First item purchase is assumed to be the first item sold
    • Based on earliest purchase cost
  • Weighted average cost (5)
    • Simple and objective
    • Cost per unit of inventory = total cost of goods available for sale/total quantity available for sale
    • COGS = average cost per unit * number of units sold
    • Ending inventory = average cost per unit * number of units
    • Value between those produced by FIFO and LIFO
  • LIFO (6) 
    • is allowed under US GAAP but not allowed under IFRS
    • Item purchase most recently is assumed to be the first item
    • In an inflationary environment, LIFO COGS > FIFO COGS → earning lower → lower income taxes

Account for changes in inventory using:

  • Periodic inventory system (7)
    • Inventory values and COGS are determined at the end of the accounting period
    • No detailed records of inventory
    • Inventory acquired during the period is reported in Purchase account (9) 
    • End of period: 
      • Cost of goods available for sale (10) = beginning inventory + Purchase
      • COGS = goods available for sale – ending inventory
  • Perpetual inventory system (8)
    • Inventory values and COGS are updated continuously 
    • Inventory purchase/sold is recorded directly in inventory when the transaction occurs
    • Purchase account is not necessary
FIFOEnding inventory and COGS are the same 
LIFOAffected by order of purchaseNot consider to order of purchase

COGS calculation with stable or increasing inventory quantities

  • FIFO COGS < LIFO COGS as cost of the last unit purchased is larger than the cost of the first goods purchased due to inflation. 

Ending inventory with stable or increasing inventory quantities

  • LIFO ending inventory < FIFO ending inventory

Ending inventory (11) 

  • When prices are rising or falling, 
    • FIFO provides the most useful measure of ending inventory
    • LIFO is based on older costs that may differ significantly from current economic value


  • Change price generate significant difference between COGS under LIFO and FIFO

Gross profit 

  • Gross profit = revenue – COGS → gross profit is affected by the choice of cost flow method