Question

what is the difference between the Average cost method, LIFO method, FIFO method, and Specification Identification method?

why do you recommend the average cost method?

what are the consequences they may have on the valuation of the inventory and determination of the net income in case of price fluctuation?

Answer 1

• Average Cost method means the total amount of purchases during the period divided by the number of units.
• LIFO Method means Last-In and First-out that is the units purchased in last will first be removed from inventory. Following this, the oldest product of inventory will be removed at last.
• FIFO Method means First-In and First-out that is the units purchased first will first be removed from inventory. Following this, the oldest product of inventory will be removed first.
• Specification Inventory method is the easiest inventory method where each product is ear-marked with a code. It is used where there are heterogeneous products.

• The average cost method is recommended especially where the prices of purchases during the period are volatile. As the Average Cost Method depicts amount at an average of high and low prices of purchases made.
  
• Valuation of Inventory may differ in LIFO, FIFO and Average cost method. If the recent purchases are at high prices, the LIFO method will depict higher valuation as compared to the FIFO method. Net profit will be accordingly impacted as in above example high LIFO valuation of COGS will make profits low and vice-versa. Average Cost method will provide average profits in comparison to lower profits in LIFO and higher profits in FIFO.

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