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Inventory Costing

# Inventory Costing - Inventory Costing Inventory is...

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Inventory Costing Inventory is accounted for at cost. Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. After a company has determined the quantity of units of inventory, it applies unit costs to the quantities to determine the total cost of the inventory and the cost of goods sold. This process can be complicated if a company has purchased inventory items at different times and at different prices. For example, assume that Crivitz TV Company purchases three identical 46-inch TVs on different dates at costs of \$700, \$750, and \$800. During the year Crivitz sold two sets at \$1,200 each. These facts are summarized in Illustration 6-2 . Illustration 6-2 Data for inventory costing example Cost of goods sold will differ depending on which two TVs the company sold. For example, it might be \$1,450 (\$700 + \$750), or \$1,500 (\$700 + \$800), or \$1,550 (\$750 + \$800). In this section we discuss alternative costing methods available to Crivitz. Specific Identification If Crivitz can positively identify which particular units it sold and which are still in ending inventory, it can use the specific identification method of inventory costing. For example, if Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is \$1,500 (\$700 + \$800), and its ending inventory is \$750 (see Illustration 6-3 ). Using this method, companies can accurately determine ending inventory and cost of goods sold.

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Illustration 6-3 Specific identification method Ethics Note A major disadvantage of the specific identification method is that management may be able to manipulate net income. For example, it can boost net income by selling units purchased at a low cost, or reduce net income by selling units purchased at a high cost. Specific identification requires that companies keep records of the original cost of each individual inventory item. Historically, specific identification was possible only when a company sold a limited variety of high-unit-cost items that could be identified clearly from the time of purchase through the time of sale. Examples of such products are cars, pianos, or expensive antiques. Today, with bar coding, electronic product codes, and radio frequency identification, it is theoretically possible to do specific identification with nearly any type of product. The reality is, however, that this practice is still relatively rare. Instead, rather than keep track of the cost of each particular item sold, most companies make assumptions, called cost flow assumptions , about which units were sold. Cost Flow Assumptions Because specific identification is often impractical, other cost flow methods are permitted. These differ from specific identification in that they assume flows of costs that may be unrelated to the actual physical flow of goods. There are three assumed cost flow methods: 1. First-in, first-out (FIFO) 2. Last-in, first-out (LIFO) 3. Average cost There is no accounting requirement that the cost flow assumption be consistent with the physical movement of the goods. Company management selects the appropriate cost flow method.
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