subject: Inventory Methods [print this page] In Accounting there are four ways to record inventory. They are specific identification, first-in first-out (FIFO), last-in first-out (LIFO), and weighted average. I will be discussing how to use all four of these methods and the pros and cons of each method. I'll first start with the specific identification method. This is probably the easiest method to use because it gives tell you exactly the cost of each unit that is sold. Most companies that use this method are car dealerships, builders, or companies with relatively low sales at a higher cost of dollars. For an example of this lets say that you start with 5 units at $100 and you buy 6 units at $105. You then sell 3 units at $100 and 2 units at $105; you would record this sale and are left with 2 units at $100 and 4 units at $105. With using specific identification each time there is a sale made the number of units and cost of units is always given.
The next way to record inventory is by using the first-in first-out method or FIFO. This method means that the first units purchased are the first units to be sold away. Lets say that you first purchase 7 units at a cost of $80. You then decide to purchase 8 more units at $90. Later that week you sold 10 total units and you want to use the FIFO method. You would record the first 7 units at $80 and 3 units at $90. You are then left with 5 units at $90. Then if you purchase 5 more units at $95 when you would go to sell the next set of units you would start with the 5 units at the cost of $90 and then move into the units at a cost of $95. When using FIFO you start with the oldest purchased units and move them out first and then move out the newest units. FIFO is probably the most used way of doing inventory because any company can easily use this method.
Another method in which to record inventory is LIFO or last-in first-out. This method is not commonly used by companies because it keeps the older units available for the ending inventory. The way to record LIFO is if a company starts with a beginning inventory of 10 units at $75 the next units that they purchase is the first to leave. If the company purchases 6 units at $80 and then they sell 10 units the 6 units at $80 is the first to go and then you add the 4 units at $75. What is left is 6 units at $75 and if another purchase is made those units would be sold first before the 6 units at $75 will be used.
The last method of recording inventory is weighted-average. When using this method it takes the average cost of the units available for sale and dividing that number by the number of units on hand and that equals your cost per unit. Lets say that a company has a beginning inventory of 10 units at $100 and then purchases 5 units at $105. Start by finding the total inventory balance which is $1,525; then divided that number by the total number of units which is 15. When the company does this they get $101.67 which is the cost per unit. The company then sells 8 units; the cost of each unit is $101.67 and they are left with 7 units at $101.67. They then decide to purchase 5 units at $103. Now they have to find the new cost per unit. The total inventory balance is $1,226.69 and the total number of units is 12. After dividing the inventory balance by the number of units the new cost per unit is $102.22. If the company then makes a sale each unit will be sold at $102.22. One good thing about the weighted average method is that it smoothes out large differences in price changes throughout the period.
When a company decides to use one of these methods they have to continue to use the same method period after period so that there is a consistency in records. This is known as the consistency concept. The mostly used method of inventory is FIFO, second is LIFO, followed by weighted average, and the least used method is specific identification.
