The next section of the equation represents the split of how the items must be categorized at the end of the period. If the items were sold and are no longer in the company's possession, then they show up in the cost of goods sold category. The Cost of Goods Sold account ($5,000 in the example below), an expense account, is directly related to the Inventory account because when goods are sold, the entry also includes a debit to cost of goods sold as well as a credit to inventory. This shows that the goods have been removed from the company's inventory and are now showing as a cost to the company on the balance. Therefore, it should be noted that inventory is held as an asset on the balance sheet until it is sold. Once inventory is sold, it comes out of the asset account and becomes an expense, via cost of goods sold.
COGS and Inventory as Asset
|Mar. 31||Cost of Goods Sold||$5,000|
|To record the cost portion of the sale|
Algebraic Versions of the Inventory Equation
|If solving for COGS||Beginning Inventory + Purchases − Ending Inventory = Cost of Goods Sold|
|If solving for Ending Inventory||Beginning Inventory + Purchases − Cost of Goods Sold = Ending Inventory|
|If solving for Beginning Inventory||Ending Inventory + Cost of Goods Sold − Purchases = Beginning Inventory|
|If solving for Purchases||Ending Inventory + Cost of Goods Sold − Beginning Inventory = Purchases|
Valuing Inventory Costs and Cost Flow Assumptions
Inventory Valuation Cost Flow Assumptions
Administratively, it would be very difficult to keep up with the cost of the goods if the company had to record the sale of each item individually. This is why cost flow assumptions are used. Instead of keeping up with the physical flow of inventory, the company simply makes assumptions about the flow of costs, which significantly increases the efficiency and effectiveness of the process. The physical inventory is only relevant to maintain the total number of units. However, inventory cost flow assumptions determine the assignment of costs to those units. The inventory cost flow assumptions help accountants and businesses address issues that arise when identical merchandise units are purchased at different unit costs. When the items are sold, it is necessary to calculate the costs using one of the common inventory cost flow assumptions or inventory costing methods—specific identification; first in, first out (FIFO); last in, first out (LIFO); and weighted average.
Specific Identification Illustration
First In, First Out (FIFO)
First In, First Out (FIFO) Illustration
Last In, First Out (LIFO)
Last In, First Out (LIFO) Illustration
Cost Flow Illustration
Once the weighted average cost per unit has been calculated, this rate would be used to determine the cost of goods sold. If 5 units were sold, then multiply the rate, $1.46, by the units to arrive at the total cost of goods sold, $7.30. The remaining 10 units would remain in ending inventory, and the same rate would be applied to determine their value.