Learn how inventory moves through the formula and why physical flow differs from cost flow
How Inventory Moves Through the Formula
Before you can compare FIFO, LIFO, or other methods, you need to understand the basic mechanics of inventory movement. Let's learn the concepts, then explore them hands-on.
Beginning Inventory
10 kits @ $18
= $180
Purchases
20 kits @ $20
= $400
Sales to Make
15 kits
selling @ $38 each
This is the key concept of Lesson 2. Physical flow and cost floware two different things, and understanding the difference is essential.
Physical Flow
How actual units move on and off the shelf.
- • Kits arrive from the supplier
- • Kits sit on the shelf
- • Kits get packed and shipped to customers
This is about counting boxes.
$Cost Flow
How dollar values move between accounts.
- • Purchase costs go into Inventory
- • When a sale happens, costs move from Inventory to COGS
- • Remaining costs stay in Ending Inventory
This is about assigning value.
Why they're different: When Sarah sells a kit, she physically hands one box to the customer. But for accounting purposes, she has to decide: did that box come from the $18 layer or the $20 layer? The physical box is the same either way, but the cost assignment changes her numbers.
An inventory layer is a group of units purchased at the same cost. Each time Sarah buys kits at a new price, she creates a new layer.
Sarah's Inventory Layers This Month:
When Sarah sells 15 kits, she has to "pull" cost from these layers. But which layer does she pull from first? That's where cost assignment comes in—and that's what you'll learn in Lesson 3 (FIFO and LIFO).
Now that you understand physical flow, cost flow, and inventory layers, it's time to see how cost assignment works in practice. Make 15 sales and watch how your choices affect COGS and Ending Inventory.
Your task: Sarah needs to sell 15 kits. For each sale, decide which inventory layer the cost should come from. Watch how your choices affect COGS and Ending Inventory.
Inventory tracking goes wrong in predictable places. Here are the most common errors:
1. Mixing up units and dollars
Counting 15 kits on the shelf doesn't automatically tell you their dollar value. You have to trace which layer they came from.
2. Forgetting that Goods Available = Beginning + Purchases
If you skip beginning inventory or miss a purchase, your entire calculation is off. Always verify that BI + P = GAFS before assigning costs.
3. Not realizing COGS and Ending Inventory share the same pool
Every dollar of cost has to go somewhere—either COGS or Ending Inventory. If one is wrong, the other is automatically wrong too.
4. Choosing a method without understanding why
Different methods give different results. Picking FIFO just because it "looks better" without understanding the tradeoffs can create problems with investors, lenders, and taxes.
- Goods Available for Sale = Beginning Inventory + Purchases (both units and dollars)
- Physical flow tracks units; cost flow tracks dollars
- Inventory layers form when you buy the same product at different prices
- Cost assignment is the process of deciding which layer costs go to COGS and which stay in Ending Inventory
- The same physical inventory can have different dollar values depending on how costs are assigned