Q6) Three methods of inventory cost determination: FIFO, Specific Identification, and
- Specific Identification method tracks the actual physical flow of the goods in a
perpetual inventory system ONLY. Each item is tagged with a specific unit cost so
that the cost of ending inventory and cost of goods sold can be determined at any
point in time.
This method is appropriate for goods that aren’t interchangeable and for goods that
are produced and segregated for specific projects. Used when there’s a small
number of pricy items that are easily distinguishable (e.g. by physical characteristics,
serial numbers, etc.). Example of items that appropriately use this method: jewelry,
artwork, pianos, cars.
While it works well with high-unit cost items, does not work well with other situations.
Only 4% of Canadian companies use specific ID method of cost determination.
- FIFO: where the cost of the earliest purchased goods are the first ones to be sold.
Does not necessarily mean the oldest units are in fact sold first, only that the cost of
the oldest units is recognized first. FIFO is a form of inventory cost formula, a
perpetual inventory system, where the flow of costs may not be the same as the
actual physical flow of goods, unlike specific ID.
An example of inventory type using this method: fuel storage tank at a gas station.
When the tank is refilled the gas costs different than the gas currently in the tank,
and because the gas mixes, it’s impossible to tell which batch of gas is being
pumped and which batch remains in the tank.
- Average cost formula recognizes that it isn’t possible to measure the specific
physical flow of inventory when the goods available for sale are homogeneous or
non distinguishable. Thus, using the average cost formula, the allocation of COGAFS
between COGS and ending inventory is based on the weighted average unit cost of
COGAFS / Units Available For Sale = Weighted Average Unit Cost Chapter 6
An example of inventory type using this method: Aga