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Inventory Costing

There are several ways to determine the value of your inventory and each type of appraisal has advantages. The most common type used by small businesses is average cost or weighted average cost. This is based on the average price of the same unit. Using the total cost of goods sold divided by the number of units available for sale can result in a different average cost. Multiplying the weighted average cost by the number of unsold units gives you your inventory value.

First-In, First-Out Costing (FIFO) assumes that the first goods purchased are the first goods sold and therefore the last goods purchased are those remaining in inventory. This system is often used because whenever the flow of inventory can be controlled it makes sense that the oldest items are sold first satisfying the accounting convention that the inventory should be shown in the balance at the last cost can be done. Since this method has been used for a long time, its continued use ensures consistency in comparing income calculations.

Last-In, First-Out Costing (LIFO) assumes that the most recent purchases are sold first, leaving the oldest items in inventory. One argument for using this method is to match the current cost of goods purchased with current sales revenue. As prices also rise, the income calculated using this method is less than the amount determined using other methods and results in less tax. It will reverse if the price goes down.

Another method, although less common, is the value of specific identification which requires that each item sold and each item left in the inventory be specified with respect to its purchase price. This method is not applicable to most companies. Companies that sell items that are relatively expensive, with a low number of sales and easy to identify the cost and sales price of each item may benefit from this method.

When choosing a method, consider the practical issues of how the valuation can be done accurately and with the least amount of effort, and be sure to consult your tax preparer with regard to returns. taxes.

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