Inventory Accounting Methods

Companies such as resellers or manufacturers often needs to keep products or raw materials in stock. This stock of items is called as inventory. Inventories makes up the most valuable current asset for such companies so it is important to determine and keep track of their costs. Inventory accounting is the process to do that. There are various methods for inventory accounting. Generally accepted accounting principles (GAAP) has defined such accounting methods. Four most common GAAP accounting methods are - Specific Identification Method, Weighted Average Method, FIFO Method, and LIFO Method. Choosing an appropriate method is very important because it can impact earnings and current assets of a company. A particular method can be well suited for some business types than others. Companies can choose any of these methods irrespective of how actually their inventories are sold. They must adhere to guidelines from IRS in this matter.
Specific Identification Method:
In this method companies records cost to acquire goods as well as cost of goods sold for each inventory item individually. This method is most suitable for companies which has limited inventory, cost per unit of inventory items are high and items are relatively unique. Jewelers, car dealers, art galleries etc. are the examples of businesses where this method is suitable. It is a most precise way of determining inventory prices but is too cumbersome for companies with large or medium-sized inventories.
Weighted Average Method:
In Weighted Average Method companies determines the weighted average cost of the inventory. This method is suitable for companies that maintain a large inventory of uniform items such as fuels or grains.
FIFO Method:
FIFO stands for First In First Out. In FIFO method it is assumed that the oldest inventory or the inventory which was purchased first is sold first. Inventory from recent purchases are sold later. This method is suitable for companies selling perishable goods such as food or drugs.
LIFO Method:
LIFO stands for Last In First Out. In LIFO it is assumed that the most recent purchased inventory is sold first. Prior or old inventory is sold later. A company in coal business is a good example where LIFO method is obvious. Coal on top of the coal pile is always going to be sold first.