Inventory data is useful if it reflects the current cost of replacing the inventory. companies because of potential income tax savings.Ĭomparison of Inventory Accounting Methods In the U.S., however, LIFO is used by approximately 36 percent of U.S. However, the oldest purchase costs are assigned to inventory, which may result in inventory becoming grossly understated in terms of current replacement costs. In a period of inflation, LIFO usually results in lower reported profits and lower income taxes than the other methods. This method matches sales revenue with relatively current costs. LIFO is the assumption that the most recently acquired goods are sold first. FIFO assigns current costs to inventory but older (and often lower) costs to the cost of goods sold. Thus inventory is assumed to consist of the most recently purchased units. COGS = cost of goods available for sale - ending inventoryįIFO is the assumption that the first units purchased are the first units sold.Ending inventory = average cost x units of ending inventory.Average cost = (beginning inventory + purchases) / units available for sale.This is the only method in which all units are assigned the same (average) per-unit cost. Using the weighted average cost method, the average cost of all units in the inventory is computed and used in recording the cost of goods sold. The cost flow assumption may or may not reflect the physical flow of inventory. They should be applied only to an inventory of homogeneous items. The remaining three methods are referred to as cost flow assumptions under GAAP and cost formulas under IFRS. In most cases, companies may be unable to determine exactly which items are sold and which items remain in ending inventory. However, the method becomes cumbersome and may produce misleading results if the inventory consists of homogeneous items. (Debit Cost of Goods Sold Credit Inventory.) This method achieves the proper matching of sales revenue and cost of goods sold when the individual units in the inventory are unique. Using the specific identification method, the actual costs of the specific units sold are transferred from inventory to the cost of goods sold. In some cases, it's possible to specifically identify which inventory items have been sold and which remain.
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