Memorandum

To:

Fan Company A - Partners

From:
Date:
Re:

Receivables and Inventories Valuation Technique Analysis

CONFIDENTIAL
Esteemed partners of Fan Company A, I have been asked to analyze the inventory
data for the first six months of Year 6. The purpose of this analysis was to determine
which of method or technique is best suited to Fan Company As need in valuating
receivables and inventories. Below you will find a listing of the techniques
employed in this analysis along with a short description of the findings and finally a
recommendation of which technique (method) is best for Fan Company A.
Please note that a copy of the analysis working papers is attached with this
memorandum for your viewing.
The following techniques (methods) were used in analyzing the data provided by
Fan Company A for the first 6 months of Year 6:

Periodic FIFO
Periodic average cost
LIFO in a perpetual inventory system (Perpetual FIFO)
FIFO in a perpetual inventory system (Perpetual LIFO)

Analysis Findings
Periodic FIFO
Using the Periodic FIFO technique, the ending inventory quantity is calculated by
subtracting the total units sold from the total units procured to produce the ending
inventory quantity. This process is carried out periodically, usually at the end of the
fiscal year. Using the First In First Out technique, we cost the 900 ending inventory
units using the latest cost of $58.25 each, the cost per item paid for the last shipment
of 1750 units during the procurement cycle in June. Using this method, the ending
inventory can be valued at $52,425.00 (900 x 58.25).

June 22, 2016

Periodic Average Cost

Using the Periodic Average Cost technique, the average inventory unit cost is
calculated by tallying up the dollar amounts of the inventory purchases for the year
and dividing that amount against the number of units purchased for the year. As
indicated in the attached form, our total purchases amounted to $631,037.50
(without deducting sales). This value divided by the total number of inventory items
purchased (11675 pcs.) will produce an average cost of $54.05 per inventory unit.
Finally, this average cost is multiplied by the ending number of inventory units
(900). Using this method, the ending inventory can be valued at $48,645.00 (900 x
54.05).
Perpetual FIFO
Using the Perpetual FIFO technique, it is important to note that the inventory value
is constantly in flux. Inventory is allocated its cost by age, meaning that the first
purchase costs are allocated to the first sales units notwithstanding when the sold
inventory was received. When the entire inventory from the earliest purchase
order has been depleted, costs are allocated from the next earliest purchase order.
This process continues perpetually or until all inventory has been depleted. As
shown on the attached form, monthly inventory units can be valued at different
costs. For instance, the beginning inventory balance in March consisted of 1525
units with a cost of $50.00 each. Additional purchases in March added a further
1700 inventory units to inventory at a cost of $55.00 each. There were a total of
2150 units sold in March. Using the perpetual FIFO technique, the first 1525 units
sold are allocated a cost of $50.00 each and the outstanding 625 units are allocated a
cost of $55.00 each. The remaining inventory is also allocated a cost of $55.00 each.
The remaining inventory value for March is then calculated by multiplying the
remaining inventory quantity (1075) against the allocated cost ($55.00) totaling
$59,125.00. This calculation provides us with the ending inventory value for the
period provided which is $52,245.00.
Perpetual LIFO
Using the Perpetual LIFO technique, it is important to note that the inventory value
is constantly in flux just as it is using the perpetual FIFO technique. Using this
technique, costs are allocated according to age as well, meaning that the last
purchase costs are allocated to the first sales units notwithstanding when the sold
inventory was received. When the entire inventory from the last purchase order
has been depleted, costs are allocated from the next latest purchase order. As shown
on the attached form, monthly inventory units can be valued at different costs. For
instance, the beginning inventory balance in June consisted of 550 units with a cost
of $50.00 each. Additional purchases in June added a further 1750 inventory units
to inventory at a cost of $58.25 each. There were a total of 1400 units sold in June.
Using the perpetual LIFO technique, the 1400 units sold are allocated a cost of
2

June 22, 2016

$58.25 each, the original 550 units are allocated a cost of $50.00 each, and the
remaining inventory from the purchases in June are allocated a cost of $58.25. The
remaining inventory value for June is then calculated by multiplying the original
inventory quantity (550) against its allocated cost per unit ($50.00) and the
remaining balance of the June purchase (350) is multiplied by its allocated cost
($58.25). This calculation provides us with the ending inventory value for the
period provided which is $47,887.50.
Recommendation
It is my professional opinion & recommendation that Fan Company A should use the
Periodic Average Cost technique to value current inventory. This technique is quick,
simple, and is more accurate because it uses an average cost for the full periods
pricing. FIFO and LIFO calculations can certainly turn out to be less consistent due
to a variety of reasons such as unexpected price changes on the vendors part, raw
materials scarcity, or delivery cost increases. The average cost technique will
produce a net income that is realistic and comparatively stable, which levels out the
total costs over a period and supports future financial forecasting and planning.