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Inventory Costing for Intermediate Accounting

Waste of money

After the company determines the unit quantity, it applies the total cost of goods sold and the cost of goods sold to the quantity. If a company knows exactly which specific items are being sold and are still in the final inventory, they can use the special identification method of supply pricing. Using this method, companies can accurately determine ending inventory and cost of goods sold. The company is required to keep a record of the cost of each item. Unique identifiers have traditionally been used to keep records of products such as cars, pianos or other luxury goods from the time of purchase to the time of sale, as bar codes are used today. This current practice is relatively uncommon in most companies involved in cost forecasting.

The cost flow assumption is different from the specific indicator of the cost flow assumption which may not be related to the flow of physical goods. There are three methods considered including (FIFO), (LIFO), and (Average-Cost). Business managers often choose the most appropriate cost flow method.

The first-in, first-out (FIFO) method assumes that the first goods purchased are the first to be sold. It usually corresponds to the flow of goods. Therefore, the cost of goods first purchased is known first in determining the cost of goods. The final inventory is based on the cost of the last purchased items. The company obtains the final inventory cost by taking the unit cost of the last purchase and working backwards until all unit costs are met. For management, higher income is a bonus. It makes external users look at the company more favorably. In addition, management compensation, if based on income, will be higher. Therefore, when prices rise, companies prefer to use FIFO because it generates higher revenue. A major advantage of the FIFO method is that in periods of inflation, the costs allocated to ending inventory will be equal to current costs.

The last in first out (LIFO) method assumes that the last item purchased is the first to be sold. LIFO does not match the actual physical flow. The cost of the last item purchased is first identified in determining cost of goods sold. Closing inventory is based on the cost of the oldest units purchased. The company obtains inventory cost by taking the unit cost of the first salable item and working up until all unit costs are met.

The average cost method divides the cost of goods sold by the weighted average cost; he also thinks that goods are similar in nature. The company applies the weighted average cost of the items on hand to determine the ending inventory cost. You can check the cost of goods sold using this method by multiplying the units sold by the average cost.

Each of the three cash flow methods considered can be used. 44% of large US companies use the FIFO method. These include companies like Reebok International Ltd. and Wendy’s International. 33% use the LIFO method including companies such as Campbell Soup Company, Kroger’s, and Walgreen Drugs. 19% use the medium price method including Starbucks and Motorola. Some companies may use more than one. Black and Decker Manufacturing Company uses LIFO for domestic inventory and FIFO for foreign inventory. The reasons why companies use different cash flow methods vary but they usually have three main reasons. First the income statement is affected secondly the balance sheet effect and finally the tax effect.

Regardless of how a company’s value flows, they should use it consistently from one accounting rule to another. This approach is often referred to as a consistent principle, which means that a company uses the same accounting principles and methods year after year. Consistency improves the comparability of financial statements across periods. Using FIFO one year and LIFO the next will make it difficult to compare earnings between the two years.

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