Accounting: Methods of Managing Inventory

Accounting: Methods of Managing Inventory

When in business companies use different ways to handle the inventory they have so that they are not losing money. Not every company is the same and some techniques work better than others for these companies. There are four methods in all and they include FIFO, LIFO, weighted average, and specific identification. I will address and explain each of the methods in this article.

The first of the methods of managing a company's inventory is the FIFO method. FIFO, which stands for first in first out, takes the inventory items that are the oldest or the one's that have been shipped to the company first are the first items that are sold by that company. The newer items that are shipped to the company have to wait until the items that have been there longer than them are sold before the newer items can be sold themselves. This method is very efficient when prices for the items are steady, but when the price values change this method is not always the most effective one. An advantage of using FIFO is that if market prices for items are falling then this method works because it is selling the items that were more expensive first. Another advantage of using this method is that it is easier to understand than the LIFO method.

The next method of managing inventory is the LIFO method. LIFO, which stands for last in first out, takes the items that are shipped in last to the company and it sells those items first. If a company has items shipped to them a lot the items that they had gotten before that they never sold will stay in the inventory until they are out of the newer items. LIFO is a very popular way of managing inventories and many companies in the United States use this technique. An advantage of this method is that, since as soon as the company is getting the item they are selling it, the companies are gaining cash advantage, which is cutting down on the costs of the income taxes. One disadvantage for this method are that if a company employs this method they cannot change their method of inventory for years unless they get the permission of the Internal Revenue Service, which is the IRS. Another disadvantage of this method is that the inventories of the companies can be depleted of items.

The third method of managing inventory is the weighted average method. The weighted average method takes the average of the items in the inventory and gives them all an average cost. Now, to the company, each item has the same average cost value and it puts all of the items in the inventory on an equal level. This is helpful because as a company it is no longer needed to worry about the different costs of groups of items when you are selling them because every item has an equal value. Some advantages of using this method are that it smoothes out changes in the purchase price and that it is a lot less complicated than using FIFO and LIFO. A disadvantage of the weighted average method is that since it is an average the average cost may go to more than 2 decimal places.

The final method of managing inventories is the specific identification method. This method is a lot different from the others because the items are each priced specifically and very few companies can use this technique. Companies can't use this technique if they get huge orders because keeping track of the different costs of every single item wouldn't be smart or effective to those companies because it would be to time consuming and wouldn't be cost effective.

In conclusion there are four methods of managing a companies inventory and they are FIFO, LIFO, weighted average, and specific identification. Each method has their own unique advantages and disadvantages and the popularity of each method may change with the economy. While LIFO is the most popular method that is being used in the United States now it has not always been that way and in the future it may change to one of the other 3 methods.

Accounting: Methods of Managing Inventory

By: Donald Shupp

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