Accounting approach to valuation inventory.
There are 4 methods to valuation inventory: Specific Identification, FIFO, LIFO, or Weighted Average
. FIFO: This method is First-In-First-Out,so the cost of the first parches unit will be recorded as the first cost when selling items from inventory. advantage of this method is a lower cost of goods sold in income statement that mean high income
. LIFO: This method is Last-In First-Out; that means any item purchases it recently; it will sell and record it as cost of goods,this method shows highest cost of goods sold in incoe statement that mean lowest net income.
Weighted Average: in this method, is calculate average cost of one unit of products then record than in all units cost.
Specific Identification: This method is allowed to determine an accurate cost for every kind of goods, so should identify each unit individually.
For example, Suppose we have merchandise company to supply electronic machines, and they purchased 40 units in 2 shipments within two weeks. Each shipment contains 20 units, the unit cost in the first shipment is 100$ , and the unit cost in the second shipment is 200$.
FIFO: According to FIFO, the method is First-In-First-Out.The cost of first parches unit it will be recorded as First cost, when sell item from inventory,
After A WHILE the company sold 10 units, So According to FIFO method, the cost of goods sold should be recorded from first shipment at 100$ per unit,
Now there are 10 units from first shipment, If the company sold 15 after a while, the cost of goods sold should be recorded 10 unit at 100$ from first shipment and the 5 units should be recorded 5 unit at 200$ from second shipment.
LIFO: According to LIFO in this method is Last-In First-Out, that means any item purchases it recently, it will sell and record it as cost of goods, this method shows the highest cost of goods sold in income statement that mean lowest net income.
After A WHILE the company sold 10 units, So According to LIFO method, the cost of goods sold should be recorded from the second shipment at 200$ per unit,
Now there are 10 units from the second shipment, If the company sold 15 after a while, the cost of goods sold should be recorded 10 unit at 200$ from the second shipment and the 5 units should be recorded 5 unit at 100$ from first shipment.
Weighted Average: according to Weighted Average: in this method, we calculate the average cost of one unit of products then record that in all units cost,So we calculate Average per unit.
Total number of electronic machine = 20+20= 40 products
Total cost of unit available fo sale = 20*100 + 20*200 = 6000 $
So, the Weighted Average cost oer unit = 6000 / 40 = 150$
After A WHILE the company sold 10 units, So According Weighted Average method, the cost of goods sold should be recorded as Weighted Average cost oer 150$ per unit, If company sold 15 after a while, the cost of goods sold should be recorded 10 unit at 150$ and the 5 units also recorded 5 unit at 150$. The average is fixed, but when the company adds another kind of product must be calculated Weighted Average for all units cost.
Specific Identification: according to This method is allowed to determine an accurate cost for every kind of goods,so should be identify each unit individual.
After A WHILE the company sold 10 units from first shipment , So According Specific Identification method, the cost of goods sold should be recorded 100 $ from first shipment. And after a while the company sold 5 units from second shipment, the cost of goods must be recorded as 200$ from the second shipment.
So, if you manager, must be decide any method use to valuation inventory.
If I manager, I would use LIFO method, because this method is the highest cost of goods sold in the income statement, which taxable is lower value, Finally, the company pays low taxes for government.
