Inventory costing, also called inventory cost accounting, is when companies assign costs to products they have in inventory. These costs also include incidental fees such as storage, administration and market fluctuation.
What Is Inventory Costing?
Inventory Costing or Inventory Cost accounting is regarded as the process of collecting, analyzing, summarizing, and evaluating various alternative courses of action involving costs and advising the management on the most appropriate course of action based on the cost efficiency and capability of the management.
Companies can use one of several inventory costing systems to keep track of which inventory is sold when. Some products have a shelf life, so ensuring the newest or oldest products are sold first is vital. Additionally, manufacturers may change the cost of products over time. Thus makes accounting for the cost of a group of items all purchased for different amounts, a complex task.
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Inventory costing helps businesses accurately inventory and account for their product costs. 4 Common inventory costing methods include:
First In, First Out (FIFO)
With first in, first out, the original cost of the item is assigned to the first item sold, even if that specific item was not actually purchased at that price. Once the number of items purchased at the initial price has sold, the company adjusts the inventory price as needed.
FIFO method assumes the first goods purchased are the first goods sold. In some companies, the first units in (bought) must be the first units out (sold) to avoid large losses from spoilage. Such items as fresh dairy products, fruits, and vegetables should be sold on a FIFO basis. In these cases, an assumed first-in, first-out flow corresponds with the actual physical flow of goods.
Last In, First Out (LIFO)
The last in, first out method uses the opposite approach of first in, first out. The company assigns the most recent cost to purchase the inventory to the first items sold and then moves to the original cost.
Average Cost Method
Using the average cost inventory costing methodology would assign costs to inventory sold by calculating an average of all costs of buying inventory. Each piece of inventory is then assigned this average cost; Instead of costs tied to the time of purchase or the age of product.
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With the average cost method, the company takes the average of all inventory purchase prices and assigns that single figure to all inventory sold; Rather than establishing different costs for different sets of the same product.
Specific Identification Method
The specific identification method of inventory costing attaches the actual cost to an identifiable unit of product. Firms find this method easy to apply when purchasing and selling large inventory items. Under the specific identification method, the firm must identify each unit in inventory, unless it is unique, with a serial number or identification tag.
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