Question

What are the four different methods used to assign costs to ending inventory and cost of goods sold? How are the methods different? What impact does each method have on the calculation of net income and ending inventory?

Answer 1

Four different methods used to assign costs to ending inventory and cost of goods sold are as follows:

1. Specific identification method

2. FIFO (first in first out) method

3. LIFO (Last in first out) method

4. Weighted average method

In specification identification method, each item in Inventory and cost of goods sold can be match purchase price in invoice. It can be known from records that exactly which item is sold and when it is sold.

In FIFO, the Inventory items are sold in order of their acquisition. It means Inventory acquired first is sold first. Therefore, the cost of recent purchases in included in the ending inventory.

In LIFO, Inventory items are sold in reverse order of their acquisition. It means the cost of goods include the value from latest purchases. Ending inventory is assigned the cost of earliest purchases.

In weighted average cost method, both cost of goods sold and. Ending inventory is assigned as per weighted cost per unit. Weighted average cost per unit is calculated by dividing total cost by total units.

In case of FIFO, the ending inventory will be lowest and therefore High cost of goods sold and reducing net income and taxes

In case of LIFO, the ending inventory will be highest and therefore low cost of goods sold and high net income.