Are you looking to enhance your annual parts inventory and improve the financial health of your automotive parts department? Then understanding ending inventory is key!
Ending inventory is the value of the automotive parts you have available for sale at the end of a given accounting period. It is calculated by adding beginning inventory and purchases, then subtracting cost of goods sold (COGS).
IT is calculated by the equation:
Ending inventory = Beginning Inventory + Purchases – COGS
Ending inventory is listed on the balance sheet and is used as the beginning inventory for the following accounting period.
It is especially important for this number to be accurate when you are trying to obtain financing or are selling your business. That being said, maintaining accurate inventory numbers throughout the year is critical to the proper management of automotive inventory.
There are many valuation methods that can be used to determine the dollar value of ending inventory. The inventory valuation method you choose to use for your parts department will impact financial statements so it is important to consider your department's goals. You also need to consider GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards) restrictions.
The two most common valuation methods for calculating ending inventory are LIFO and FIFO. Here is a quick breakdown of each.
FIFO (First In, First Out)
For most businesses, the flow of materials is first in first out, meaning that the oldest items are taken off the shelf first allowing newer, fresher stock to be left on the shelves. In some industries, such as those selling food and beverage products, this flow is made necessary through expiry dates.
While automotive parts do not have best before dates, time can sometimes degrade parts and therefore, older parts should be used up first. Choosing the FIFO method, in this situation, is the most logical choice.
When it comes to cost layering (layers are created every time you add units to inventory), FIFO usually has fewer layers. This is because the oldest units are constantly being sold.
Using FIFO can also be beneficial in times of inflation. That is because, in general, as suggested retail prices increase, so do the profits on parts that were purchased when prices were lower. FIFO will allow you to report increased profits on your financial statements. This, however, can also increase income tax payable at the end of the year. If costs are decreasing, the first parts you purchased will have a higher COGS than those that were purchased most recently. This means your profits would be lower, and your tax liability should decrease.
FIFO is allowed under GAAP, IFRS and can be used to report income to the IRS during tax season. That means you will only have to value your inventory once using FIFO.
LIFO (Last In, First Out)
When using LIFO, the cost of the most recent product purchased is the first to be expensed to COGS. If you use LIFO in a period of deflation, your profits will increase and so would your tax liability. In a period of inflation, it would have the opposite effect – profits would be lower and tax liability should decrease.
Record keeping is also more complex with LIFO. This is because, on paper, the oldest layers can remain in stock for years, depending on how often you repurchase new stock without completely depleting what you currently have on hand. This can create more layers, therefore increasing the amount of record keeping.
LIFO is prohibited under GAAP and IFRS but the IRS allows you to use either LIFO or FIFO.
As such, you may choose to use FIFO for internal reporting, and LIFO for reporting to the IRS. This may be beneficial if you are constantly experiencing inflation as it will lower your tax liability but will require you to value your inventory twice.
For more information on inventory management for your dealership, please contact us today.
Tags: Auto Parts Inventory