Hi,

The proper way depends on the circumstances surrounding the business. There are many methods used to compute cost of goods sold depending on the industry. For example, an oil refinery would use process accounting. Inventory would consist of three categories of raw amterial, work-in-process and finished good. Cost would be accumulated as the goods moved through various processes of refining, from petroleum until it became gasoline. Costs directly related to producding the finisted goods might be charged out at some standard based on experience with variance analysis on job completion to compare standard cost to actual. Usally, in this type of operation all cost directly related to producing the finished product, including labor and overhead allocations, would be added to the inventory.

A retailer might used the gross prfit method to determine inventory which involves estimates. An actual phically count by the retailer would be necessary once each year to compute exactly the value of inventory on hand.

An auto dealership might use a perpetual inventory system to determine cost of good sold. In this method costs are charge out as individual items are sold. Again, all cost directly associated with the product should become a part of the items cost for inventory purposes.

Also, inventory can be charge out under a number of method like first in first out, last in first out, or average.

Another method of cost accounting is product costing or job order costing. Again, all direct cost to produce the finished product, including direct labor and overhead allocations, should be charged to the item of inventory with expense resulting at the point the item is sold.

The important thing to remember in any accounting system is that whatever procedures are adopted, they should be consistently applied from year to year. Switching from first in first out to last in first out between years can cause all kinds of problems. Also, switching the inventory method to charge all direct costs and allocated overhead to inventory during lean years for the purpose of making the financail statement look good could cause user of the financial statement to be mislead, and result in serious consequences to the company manipuling the costs. If whatever method selected is consistently applied, then the cost of good would be correct over a reasonable period of years. If changes are made to the method used to determine inventory, financial statement of previous year would need to be restated for purposes of presenting comparative financial statement between years.

LelandJ