Unpacking Inventory Accounting for the U.S. FAR CPA Exam
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
Inventory affects everything from a company's profitability to its liquidity, and it's a well-tested topic on the FAR section of the CPA exam.
What counts as inventory?
Inventory consists of tangible property held for sale in the ordinary course of business, in the production process, or to be used in manufacturing. It's typically broken into raw materials, work-in-process, and finished goods.
What inventory valuation methods does U.S. GAAP allow?
- First-In, First-Out (FIFO)
- Last-In, First-Out (LIFO)
- Average cost method
How is inventory initially measured?
Under U.S. GAAP, inventory is initially measured at cost, which includes all expenditures directly attributable to bringing it to its current condition and location.
Purchasing inventory: A business buys $10,000 worth of raw materials.
- Debit Inventory $10,000
- Credit Accounts Payable $10,000
Selling inventory: The company sells inventory that cost $4,000 for $7,000.
- Debit Accounts Receivable $7,000
- Credit Sales Revenue $7,000
- Debit Cost of Goods Sold (COGS) $4,000
- Credit Inventory $4,000
How do FIFO and LIFO change which costs hit COGS?
Suppose a company starts with $2,000 of opening inventory, purchases another $3,000 of inventory, and then sells $4,000 worth of goods. FIFO and LIFO allocate that same $4,000 of COGS differently:
FIFO: the oldest inventory is sold first, so COGS draws from the $2,000 opening balance before touching the new purchase.
- Debit COGS $4,000
- Credit Inventory $4,000
That $4,000 breaks down as $2,000 from the opening inventory and $2,000 from the new purchase.
LIFO: the most recently purchased inventory is sold first, so COGS draws from the new purchase before touching the opening balance.
- Debit COGS $4,000
- Credit Inventory $4,000
That $4,000 breaks down as $3,000 from the new purchase and $1,000 from the opening inventory.
What gets disclosed?
Companies must disclose their inventory accounting policies, valuation methods, and any writedowns — information investors and analysts need to accurately evaluate the company's financial standing.
The valuation method you choose doesn't change how much inventory gets sold — only which costs get assigned to it. FIFO pulls from the oldest costs first, LIFO from the most recent, and both must reconcile back to the same total units sold.
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 95 on FAR. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.