Types of Inventory Methods

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Types of Inventory Methods

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There are two basic types of inventory methods namely the Specific Identification method and the Cost Flow Assumption method. Companies choose their inventory method depending on various factors like the nature of their business etc. The Specific identification method is used to determine the particular goods sold and which ones are still in ending inventory. Specific Identification is possible only in companies that sell a very limited variety of high cost items that can be and are easy to identify right form the time of purchase till the time of their sale. Due to this characteristic of the Specific Identification method I would advise Mr. Koblet, to use this method for his Inventory Costing, owing to the nature of his business which is a car dealership which requires a method that can specifically identify each individual vehicle, which is generally done by giving each vehicle a identification number that becomes its ID. The Cost Flow Assumption is generally used in businesses where specific identification of particular goods is almost impractical. There are three types of Cost Flow Assumptions namely:

1) First In Fist Out (FIFO)

2) Last In First Out (LIFO)

3) Average Cost

In the (FIFO) method it is assumed that the earliest goods purchased are the first to be sold. Under this assumption the costs of the earlier goods purchased are first to be recognized as the cost of goods sold. The cost of the ending inventory under (FIFO) is obtained by taking the unit cost of the most recent purchase and working backward until all units of inventory have been covered. This system would never work for a car dealership as in a car dealership there probably will be cars belonging to different manufactures like Ford etc and having different models with different features, with a specific price assigned to the particular model of a particular manufacturer. If (FIFO) was to be used in this kind of business it could lead to a lot of false financial information showing higher or lower ending inventories which will in turn affect the cost of goods sold as under this system we would only take the unit cost of the most recent cars regardless of their models and features which could be either much cheaper than the ones sold or much more expensive than the ones sold.

Under the (LIFO) method it is assumed that the latest goods purchased are the first to be sold.

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