Question

Give examples of specific companies that you would logically think should use each of the following inventory valuation methods (at least one company per method):

-Specific identification

-First-in, First-out (FIFO)

-Last-in, First-out (LIFO)

-Weighted average cost

Now identify reasons that a company may not use the most obvious logical cost flow valuation method, hence, the reason these are considered cost flow assumptions.

Answer 1

specific identification;

first-in, first-out (FIFO);

last-in, first-out (LIFO); and

weighted-average.

Each method has advantages and disadvantages. Note that a manufacturing business’s inventory will consist of work in process, or unfinished goods, and finished inventory; the costs of unfinished and finished inventory contain a combination of costs related to raw materials, labor, and overhead. On the other hand, a retailer’s inventory consists of all finished products purchased from a wholesaler or manufacturer; the costs of their units are based on their acquisition cost rather than the costs associated with manufacturing units.

Specific Identification

The specific identification method of inventory costing attaches the actual cost to an identifiable unit of product. Firms find this method easy to apply when purchasing and selling large inventory items such as cars. Under the specific identification method, the firm must identify each unit in inventory, unless it is unique, with a serial number or identification tag.

FIFO (first-in, first-out)

The FIFO (first-in, first-out) method of inventory costing assumes that the costs of the first goods purchased are those charged to cost of goods sold when the company actually sells goods. This method assumes the first goods purchased are the first goods sold. In some companies, the first units in (bought) must be the first units out (sold) to avoid large losses from spoilage. Such items as fresh dairy products, fruits, and vegetables should be sold on a FIFO basis. In these cases, an assumed first-in, first-out flow corresponds with the actual physical flow of goods.

LIFO (last-in, first-out)

The LIFO (last-in, first-out) method of inventory costing assumes that the costs of the most recent purchases are the first costs charged to cost of goods sold when the company actually sells the goods.

Weighted-average

The weighted-average method of inventory costing is a means of costing ending inventory using a weighted-average unit cost. Companies most often use the weighted-average method to determine a cost for units that are basically the same, such as identical games in a toy store or identical electrical tools in a hardware store. Since the units are alike, firms can assign the same unit cost to them.

Calculating Cost of Goods Sold (periodic method)

Beginning Inventory + Purchases = Available for Sale

Available – Ending Inventory = Cost of Good Sold