This outcome asks you to value closing inventory and cost of sales using FIFO or weighted average cost, under either the periodic or the continuous system. The examiner likes it because one slip in which units or which prices you use gives a wrong answer that looks plausible.
The rule
FIFO assumes the oldest units are sold first, so closing inventory is made up of the most recent purchases. Weighted average cost is total cost of goods available divided by total units available, which is not the simple average of the prices. Periodic calculates once at the year end using all purchases. Continuous recalculates after every receipt, using the balance held at that date. FIFO gives the same answer under both systems. Inventory is then carried at the lower of cost and NRV, item by item (IAS 2).
Worked example
Opening inventory 100 units at $10. Sold 50 units. Then bought 100 units at $13. Closing units = 100 + 100 − 50 = 150.
Periodic weighted average: cost available = $1,000 + $1,300 = $2,300 for 200 units, so $11.50 per unit. Closing inventory = 150 × $11.50 = $1,725. Cost of sales = 50 × $11.50 = $575.
Continuous weighted average: after the sale, 50 units at $10 = $500. After the purchase, 150 units cost $500 + $1,300 = $1,800, so $12 per unit. Closing inventory = $1,800.
FIFO: the sale uses 50 of the $10 units. Closing = 50 × $10 + 100 × $13 = $1,800, the same under periodic and continuous.
Remember: under FIFO closing inventory is priced from the newest layers, and a weighted average is total cost divided by total units, never the simple average of the prices.
Where candidates lose marks
Taking the simple average of unit prices (for example $9.00 from $8, $9 and $10) and ignoring the different quantities bought at each price.
Pricing closing inventory from the oldest cost layers instead of the latest purchases under FIFO.
Using the closing inventory value as cost of sales, or dividing a layer's cost by the wrong number of units when working back to a purchase price.
Skipping the NRV comparison, or writing down only the obviously impaired line instead of comparing NRV with the actual cost of each item.
Try it: 4 questions
BlueCo Co uses the periodic FIFO cost formula. Activity for 20X2 on three product lines was as follows:
BlueCo Co applies the lower of cost and net realisable value item by item. At what amount should inventory be reported in BlueCo Co's statement of financial position at 31 December 20X2?
Answer: A. IAS 2 requires inventory to be measured at the lower of cost and NRV, normally item by item (IAS 2 para 29). Under FIFO, closing inventory comes from the most recent purchases. Product A: 250 × $14 = $3,500 cost, NRV $3,375, so carry $3,375. Product B: 150 × $22 = $3,300 cost, NRV $3,150, so carry $3,150. Product C: 100 × $24 = $2,400 cost, NRV $2,000, so carry $2,000. The total is $8,525. $9,200 is cost with no NRV comparison. $8,800 writes down only Product C, but NRV must be compared with the actual FIFO cost of each item. $8,050 wrongly prices closing inventory using the oldest cost layers.
Hopstone Brewery Co sells one type of keg and uses the periodic weighted average cost method. For the year: opening inventory 300 units at $8.00; purchases of 500 units at $9.00 and then 200 units at $10.00; sales of 700 units at $15 each. What are the cost of sales and the gross profit for the year?
Answer: A. Total cost of goods available = 300 × $8 + 500 × $9 + 200 × $10 = $2,400 + $4,500 + $2,000 = $8,900. Total units = 1,000. Weighted average cost = $8,900 / 1,000 = $8.90 per unit. Cost of sales = 700 × $8.90 = $6,230. Sales = 700 × $15 = $10,500. Gross profit = $10,500 − $6,230 = $4,270. Option B uses the simple average of the three unit prices ($9.00), ignoring the different quantities bought at each price. Option C is the FIFO cost of sales (300 × $8 + 400 × $9 = $6,000), which is the wrong method. Option D uses the closing inventory value (300 × $8.90 = $2,670) as cost of sales.
Fitwell Clubs Ltd sells protein drinks and uses periodic FIFO. Opening inventory was 400 units at $5. Purchases were 600 units at $6, followed by 500 units at an unknown price per unit. 800 units were sold, and closing inventory is valued at $4,300 for 700 units. What was the price per unit of the latest purchase?
Answer: D. Under FIFO closing inventory is made up of the most recent purchases. Closing units = 400 + 600 + 500 - 800 = 700. These are the 500 latest units plus 200 units from the $6 purchase. The $6 layer is 200 x $6 = $1,200. The latest layer = $4,300 - $1,200 = $3,100, so the price = $3,100 / 500 = $6.20. Option A deducts the whole 600-unit $6 layer ($3,600) and divides the rest by 500. Option B deducts 200 units at the opening price of $5 ($1,000) and so takes the closing units from the oldest layer. Option C divides $4,300 by 500 units, ignoring the 200 units from the earlier purchase.
Oakwood Furniture Co values its timber at weighted average cost. Transactions for the month were: opening inventory 1,000 metres at $10 per metre; purchase of 1,000 metres at $14 per metre; sale (issue to production) of 1,000 metres; then a purchase of 2,000 metres at $16 per metre. Which of the following correctly states closing inventory (3,000 metres) under the periodic and the continuous weighted average methods, and how they differ?
Answer: B. Periodic: total cost = $10,000 + $14,000 + $32,000 = $56,000; total units = 4,000; average = $14 per metre; closing 3,000 x $14 = $42,000. Continuous: after the first purchase 2,000 metres cost $24,000 (average $12); the 1,000-metre issue removes $12,000, leaving 1,000 metres at $12,000; the second purchase adds $32,000, giving 3,000 metres at $44,000 (average $14.67). Closing inventory is $44,000, so the difference is $2,000. The sale happened before the $16 purchase, so under continuous it was costed at $12, and more of the cheap cost was removed from inventory. Option A assumes the two averages are always equal, which is the trap. Option C reverses the two figures. Option D gives the FIFO closing value (2,000 x $16 + 1,000 x $14 = $46,000), not a weighted average.
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What is the difference between periodic and continuous weighted average cost?
Periodic works out one average at the end of the period from opening inventory plus all purchases. Continuous recalculates the average after each purchase, using the units and cost held at that date, so sales are costed at the average at the time of sale.
Does FIFO give a different answer under periodic and continuous systems?
No. Under FIFO the oldest units are always the ones sold, so the same layers remain in closing inventory whether you cost sales at each sale or at the year end.
How do you calculate closing inventory under FIFO?
Work out the closing units (opening plus purchases less sales). Then price them starting from the latest purchase and work back through earlier purchases until all the units are costed.