Physically Counting the Items in Inventory
One method for calculating the cost of a company’s ending inventory is to 1) physically count the quantity of each of the items in inventory and then 2) multiply those quantities by each item’s actual unit cost.
The actual unit costs must be consistent with the cost flow assumption (FIFO, weighted-average, etc.) that was elected by the company. Special attention is required for items that are on consignment or are in transit. Taking the physical counts can be very time consuming and complicated especially when inventory items are moving between operations. As a result, large companies are likely to physically count the inventory items only at the end of the accounting year.
Using the Quantities in the Company’s Inventory System
A second method which can be used for interim financial statements is to calculate the ending inventory by using the quantities on the company’s inventory system. Those quantities are multiplied by the actual unit costs that reflect the company’s cost flow assumption. (Throughout the year the inventory system’s quantities should be adjusted to agree with any physical counts. Some companies will physically count a different group of inventory items each month and compare those counts to the system’s quantities.)
Estimating the Cost of the Ending Inventory
A third approach is to use the gross profit method to calculate the estimated cost of the ending inventories that will be used on the interim financial statements.
