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May 14, 2022 May 14, 2022/
The specific identification method is used to track individual items of inventory. This method is applicable when individual items can be clearly identified, such as with a serial number, stamped receipt date, bar code, or RFID tag. Specific Identification Method RequirementsThe principle requirements of a specific identification tracking system are as follows:
These requirements can be achieved with a simple accounting system, possibly just an electronic spreadsheet. This means that a smaller business should find it relatively easy to employ the specific identification method, especially when unit volumes are low.
The specific identification method introduces a high degree of accuracy to the cost of inventory, since the exact cost at which something was purchased can be recorded in the inventory records, and charged to the cost of goods sold when the related item is sold. Disadvantages of the Specific Identification MethodThis method is rarely used, because there are few purchased products that are clearly identified in a company's accounting records with a unique identification code. Thus, it is typically restricted to unique, high-value items for which such differentiation is needed. Most organizations instead sell products that are essentially interchangeable, and so are more likely to use a FIFO, LIFO, weighted average, or similar system. It is also very time-consuming to track inventory on an individual unit basis, which restricts its use to smaller inventory quantities. Examples of the Specific Identification MethodExamples of situations in which the specific identification method would be applicable are a purveyor of fine watches or an art gallery. May 14, 2022/ When selecting an inventory method, managers should look at the advantages and disadvantages of each.
Summarize the differences between LIFO, FIFO, and Specific Identification and explain how a company would use that information to select an inventory method KEY TAKEAWAYSKey Points
Key Terms
Companies that use the specific identification method of ‘inventory costing' state their cost of goods sold and ending inventory as the actual cost of specific units sold and on hand. Some accountants argue that this method provides the most precise matching of costs and revenues and is therefore the most theoretically sound method. This statement is true for some one-of-a-kind items, such as autos or real estate. For these items, use of any other method would seem illogical. However, one disadvantage of the specific identification method is that it permits the manipulation of income. Advantages and Disadvantages of FIFOThe FIFO method has four major advantages:
All the advantages of FIFO occur because when a company sells goods, the first cost it removes from inventory are the oldest unit costs. The cost attached to the unit sold is always the oldest cost. Under FIFO, purchases at the end of the period have no effect on cost of goods sold or net income ([fig:11053]]). The disadvantages of FIFO include the recognition of paper profits and a heavier tax burden if used for tax purposes in periods of inflation. An example of how to calculate the ending inventory balance of the period using FIFO - assume the following inventory is on hand and purchased on the following dates:
Advantages and disadvantages of LIFODuring periods of inflation, LIFO shows the largest cost of goods sold of any of the costing methods because the newest costs charged to cost of goods sold are also the highest costs. The larger the cost of goods sold, the smaller the net income. Those who favor LIFO argue that its use leads to a better matching of costs and revenues than the other methods. When a company uses LIFO, the income statement reports both sales revenue and cost of goods sold in current dollars. The resulting gross margin is a better indicator of management ‘s ability to generate income than gross margin computed using FIFO, which may include substantial inventory (paper) profits. An example of how to calculate the ending inventory balance of the period using LIFO - assume the following inventory is on hand and purchases are made on the following dates:
Advantages and Disadvantages of Weighted-AverageWhen a company uses the weighted-average method and prices are rising, its cost of goods sold is less than that obtained under LIFO, but more than that obtained under FIFO. Inventory is not as understated as under LIFO, but it is not as up-to-date as under FIFO. A company can manipulate income under the weighted-average costing method by buying or failing to buy goods near year-end. However, the averaging process reduces the effects of buying or not buying. The following is an example of the weighted average cost method:
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