How to Solve for Ending Inventory: Methods & Formulas

Ending inventory represents the value of goods a business has on hand at the close of an accounting period. It is a fundamental metric reflecting the unsold products available for future sales. This figure is a direct indicator of a company’s remaining assets. Accurately determining ending inventory is an accounting task for any business that deals with physical goods.

Key Components for Inventory Calculation

Before calculating ending inventory, beginning inventory must be established. The starting point for any period’s inventory calculation is the beginning inventory, which is simply the value of unsold goods carried over from the prior accounting period.

Throughout an accounting period, a business acquires additional goods for resale, known as purchases. These purchases encompass the cost of merchandise bought from suppliers. It also includes “freight-in,” which are the transportation costs incurred to bring the inventory to the company’s location.

Combining the beginning inventory with the total purchases yields the Cost of Goods Available for Sale (COGAS). This sum represents the total value of all inventory that a company could have sold. COGAS is a figure from which both the cost of goods sold and the ending inventory are derived.

Inventory Costing Methods

Businesses use various inventory costing methods to assign value to the goods they sell and the goods remaining in inventory. One common approach is First-In, First-Out (FIFO), which assumes that the first goods purchased are the first ones sold. The inventory remaining at the end of the period is assumed to consist of the most recently acquired items.

Another method is Last-In, First-Out (LIFO), which assumes that the last goods purchased are the first ones sold. Ending inventory under LIFO is considered to be made up of the earliest acquired inventory. While LIFO is permitted under U.S. Generally Accepted Accounting Principles (GAAP), it is prohibited under International Financial Reporting Standards (IFRS).

The Weighted-Average Method provides a different approach by calculating an average cost for all goods available for sale. This average cost is then applied to both the units sold and the units remaining in ending inventory. This method smooths out price fluctuations and can be particularly useful for businesses that deal with large volumes of identical items where individual tracking is impractical.

Step-by-Step Ending Inventory Calculation

Calculating ending inventory requires a systematic application of the chosen costing method to the inventory data. Consider a scenario where a business has a beginning inventory of 100 units at $10 each, purchases 150 units at $12 each, and later purchases another 200 units at $15 each. If 300 units were sold during the period, 150 units remain in ending inventory (100 + 150 + 200 – 300 = 150).

Under the FIFO method, the 150 units in ending inventory are assumed to be the most recent purchases. Therefore, these 150 units would be valued entirely from the last purchase of 200 units at $15 each, resulting in an ending inventory value of $2,250 (150 units $15). This method reflects that the oldest costs have been expensed as goods sold.

Conversely, using the LIFO method, the 150 units in ending inventory are assumed to be from the oldest available stock. This would include the initial 100 units from beginning inventory at $10 each ($1,000) and 50 units from the first purchase of 150 units at $12 each ($600). The total ending inventory under LIFO would thus be $1,600 ($1,000 + $600). The LIFO Conformity Rule, enforced by the IRS under Internal Revenue Code Section 472, mandates that if a company uses LIFO for tax purposes, it must also use it for financial reporting to external stakeholders.

For the Weighted-Average Method, the total cost of goods available for sale is first determined by adding the beginning inventory cost ($1,000) to the cost of all purchases ($1,800 + $3,000 = $4,800), totaling $5,800. With 450 units available for sale (100 + 150 + 200), the average cost per unit is approximately $12.89 ($5,800 / 450 units). Applying this average cost to the 150 units in ending inventory yields a value of approximately $1,933.33 (150 units $12.89).

Significance of Ending Inventory

The accurate calculation of ending inventory holds considerable importance for a business’s financial reporting and operational decisions. It directly influences the Cost of Goods Sold (COGS), which is a major expense for many companies. An inverse relationship exists: a higher ending inventory generally leads to a lower COGS, and conversely, a lower ending inventory results in a higher COGS.

The impact of ending inventory extends to a company’s profitability. Since COGS is subtracted from revenue to determine gross profit, and gross profit is a component of net income, the valuation of ending inventory directly affects the reported net income. Therefore, an error in inventory valuation can distort a company’s true earnings.

Furthermore, ending inventory is reported as a current asset on the balance sheet, representing the value of goods available for future revenue generation. This asset figure provides insight into a company’s liquidity and its ability to meet future demand. The choice of inventory costing method can significantly alter the reported asset value, which in turn influences financial ratios and investment analysis.