Inventory costing methods allow you to determine the current value of the inventory items your company sells. There are two inventory costing methods available in Sage 50 Accounting.
Average Cost
A method of valuing the cost of inventory based on the average cost of the goods available for sale during a period. Average cost is calculated by dividing the total cost of goods for sale by the total units for sale. Average cost tends to level out the effects of cost increases and decreases because the cost is influenced by all the prices paid during the year. This is the standard inventory costing method in Sage 50 Accounting.
Switching from FIFO to Average Cost consolidates all of the layers for each item, creating beginning average costs.
First In First Out (FIFO) (Sage 50 Premium Accounting)
FIFO is a method of valuing the cost of goods sold that applies the cost of the oldest items in inventory first. That is, the first items added to your inventory are the first items you sell. This method is very useful for calculating cost of goods sold, especially if you are unable to specifically identify items of inventory that you purchased at different times for different prices. FIFO uses "layers" to keep track of an item's cost on its date of purchase or construction. Every time an item is purchased or built, a cost layer is created for that item.
When you first switch to FIFO, a layer is created for each item, based on their current costs and quantities.
If you are still entering your company's history, it is important to note that you cannot change the Opening Quantities or Values on an item's record once it has been used in a transaction - before or after switching to FIFO.
Specific Cost (Sage 50 Quantum Accounting)
Specific cost is a method for tracking inventory costs for individual inventory items, purchased on known dates. In Sage 50 Accounting, this method is enabled by turning on the serialized inventory feature. Every item that is added to inventory and is assigned a serial number, has a specific cost associated with it. The cost comes from the original purchase invoice and only changes if the invoice is adjusted.
In order to use specific cost, you must turn on FIFO inventory costing first. The FIFO method will be used for tracking inventory items that do not have serial numbers.
Why should a company be concerned about how it values its inventory?
Accounting control of inventory is used to determine a unit cost for inventory based on adding the purchase cost of new inventory to the present cost of existing inventory, and then dividing this amount by the combined number of items in inventory. When an existing inventory item is first purchased, its average cost is simply the purchase price divided by the number purchased. For example: if National Construction purchased 20 ladders for $300, the average cost would be $15. When items are removed from inventory they are removed at the average cost. For example, if 4 ladders are requisitioned for a project, then the value of the remaining inventory is $240, but the average cost is $15. If more inventory is bought at a price different than the average costs, the average cost of the new inventory total would be changed.
For example, if National Construction bought 16 more ladders for $208, the new average cost would be:
16 units purchased @ $15.00 = $240.00
16 units purchased @ $13.00 = $208.00
TOTAL purchase cost = $448.00
New average cost = total purchase cost ($448) divided by total number of items in stock (32) = $14.00