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SAAccountingSyllabus dot point

How does the choice of inventory system and cost flow affect reported profit?

Record inventory under perpetual and periodic systems and value closing inventory using the FIFO cost flow

The perpetual system updates inventory at every transaction; the periodic system counts at period end. FIFO assigns the earliest costs to cost of goods sold, leaving the most recent costs in closing inventory.

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  1. What this dot point is asking
  2. Perpetual versus periodic
  3. FIFO cost flow
  4. Why the system and flow matter

What this dot point is asking

You need to record inventory under both systems, value closing inventory using first-in-first-out, and explain how the choice affects profit.

Perpetual versus periodic

Cost of goods sold under the periodic system uses the inventory equation:

FIFO cost flow

When units are bought at different prices, an assumption is needed about which cost leaves first. First-in-first-out assigns the oldest costs to cost of goods sold and leaves the newest costs in closing inventory. In a period of rising prices this gives a lower cost of goods sold and a higher closing inventory, so reported profit is higher.

Why the system and flow matter

The closing inventory figure feeds straight into cost of goods sold and therefore gross profit, and it appears as a current asset. A higher closing inventory value lowers cost of goods sold and raises profit. The perpetual system also supports better control because shortages show up as a difference between the recorded balance and the physical count.

Exam-style practice questions

Practice questions written in the style of SACE Board exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

2023 SACE Stage 27 marksComplete the inventory card for Starlit Nights using the first-in, first-out method and recording any inventory discrepancy. (8 bags purchased at 230,3returnedtothesupplier,9bagsboughtat230, 3 returned to the supplier, 9 bags bought at 290, 6 then 5 sold, 1 sales return, and a final stocktake of 3 bags on hand.)
Show worked answer →

Under perpetual FIFO you update the card after every movement and always issue the oldest cost first.

  1. Purchase 8 at 230−>balance5at230 -> balance 5 at 230 (after the 3 returned to supplier at $230).
  2. Purchase 9 at 290−>balanceshowstwocostlayers:5at290 -> balance shows two cost layers: 5 at 230 and 9 at $290.
  3. Sale of 6: issue the 5 oldest at 230(230 (1,150) then 1 at 290(290 (290), COGS 1,440.Balance8at1,440. Balance 8 at 290.
  4. Sale of 5 at 290(290 (1,450) -> balance 3 at $290.
  5. Sales return of 1: the customer returns 1 unit, brought back in at its 290cost−>balance4at290 cost -> balance 4 at 290.
  6. Stocktake shows only 3 on hand, so there is an inventory discrepancy (loss) of 1 unit at 290=290 = 290. Write this out of inventory: balance 3 at 290=290 = 870.

Markers reward issuing costs in FIFO order, correct running balances and identifying and recording the stock loss separately rather than burying it in COGS.

2024 SACE Stage 22 marksCalculate the inventory turnover ratio for the month of June 2024 for the solar panels, given monthly cost of goods sold and average inventory from the FIFO inventory card.
Show worked answer →

Inventory turnover = cost of goods sold / average inventory, measured in times.

From the FIFO card, total the cost of goods sold for June (the cost of the units issued on the sales dates, net of the sales return) to get monthly COGS. Average inventory = (opening inventory + closing inventory) / 2 using the dollar balances on the card (opening $70,000 and the closing balance after the stocktake).

Divide: turnover = COGS / average inventory, expressed as "x times". A higher figure means stock is sold and replaced more often.

Markers want the formula stated, the correct COGS and average used, and the answer labelled in times. Note this monthly figure is not comparable with an annual turnover unless it is scaled, which is exactly the trap the next part of the question tests.

2022 SACE Stage 22 marksEspress Yourself uses both the first-in, first-out method and the specific-identification method. Identify one inventory item for which the business would use the specific-identification method of valuing inventory, and give a reason for your answer.
Show worked answer →

Choose a high-value, low-volume, individually identifiable item, for example the coffee machines (or coffee grinders).

Reason: specific identification tracks the actual cost of each individual unit. It suits items that are expensive, sold in small numbers and easy to identify separately (for example by serial number), so the exact cost of the unit sold can be matched to its sale. This gives a precise cost of goods sold and closing inventory value.

By contrast, low-cost, high-volume, interchangeable items such as filters or reusable cups are better suited to FIFO, because tracking each unit individually would not be worth the effort (the materiality and cost-benefit ideas). Markers want a sensible item plus a reason that links to the item being high-value and individually identifiable.