Introduction to Inventory Cost Flow Assumptions (2024)

FAQs

Introduction to Inventory Cost Flow Assumptions? ›

Inventory Cost Flow Assumptions are the rules and guidelines that companies implement to determine the value of their inventory and to calculate the cost of goods sold (COGS). These assumptions include the First-In-First-Out (FIFO) method, the Last-In-First-Out (LIFO) method, and the Weighted Average Cost method

The term cost flow assumptions refers to the manner in which costs are removed from a company's inventory and are reported as the COGS. In the U.S., the common cost flow assumptions are First-in, First-out (FIFO), Last-in, First-out (LIFO), and average.

The three most common Inventory Cost Flow Assumptions are FIFO (First In, First Out), LIFO (Last In, First Out), and the Weighted Average Cost method.

The First-in, First-out (FIFO) Cost Flow Assumption

First-in, first-out (FIFO) assumes that the first goods purchased are the first ones sold. A FIFO cost flow assumption makes sense when inventory consists of perishable items such as groceries and other time-sensitive goods.

Even under the periodic inventory system, however, inventory cost flow assumptions need to be made (specific identification, FIFO, weighted average) when purchase prices change over time, as in a period of inflation.

A company can choose to use specific identification, first-in, first-out (FIFO), last-in, first-out (LIFO), or averaging. Each of these assumptions determines the cost moved from inventory to cost of goods sold to reflect the sale of merchandise in a different manner.

FIFO is the most logical choice since companies typically use their oldest inventory first in the production of their goods. Deciding between these two inventory methods as implications on a company's financial statements as this decision impacts the value of inventory, cost of goods sold, and net profit.

Recognize that three cost flow assumptions (FIFO, LIFO, and averaging) are particularly popular in the United States. Understand the meaning of the LIFO conformity rule and realize that use of LIFO in the U.S. largely stems from the presence of this tax rule.

Accounting Standards for FIFO and LIFO in the US

FIFO is permissible under both U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). LIFO is allowed under GAAP in the U.S. but prohibited under IFRS followed outside the U.S.

cost flow assumption is based on the premise that selling the oldest item first is most likely to mirror reality. Stores do not want inventory to lose freshness. The oldest items are often displayed on top in hopes that they will sell before becoming stale or damaged.

Which of the following is true concerning inventory cost flow assumptions? ›

Regarding inventory cost flow assumptions, the statement that a company may use more than one costing method concurrently is true. This means that a company can use different inventory costing methods for different inventory items or product lines within their operations.

The three most common Inventory Cost Flow Assumptions are FIFO (First In, First Out), LIFO (Last In, First Out), and the Weighted Average Cost method.

If you're looking for a cost flow assumption that smooths your product costs over time, the weighted average cost method is the best choice. Also called the average cost method, it creates an average unit cost that results in a per-unit cost that remains consistent throughout the accounting period.

Figure 10.3 illustrates how to calculate the goods available for sale and the cost of goods sold. Inventory costing is accomplished by one of four specific costing methods: (1) specific identification, (2) first-in, first-out, (3) last-in, first-out, and (4) weighted-average cost methods.

Which inventory cost flow assumption generally results in the lowest reported amount for inventory when inventory costs are rising? Last-in, first-out (LIFO).

Answer. The LIFO method assumes the inventory is made up of the most recent costs, while FIFO assigns the oldest costs to the cost of goods sold, focusing on the items sold rather than the inventory left.

Of the three widely used inventory costing methods (FIFO, LIFO, and Weighted Average), the FIFO method of costing inventory is based on the assumption that costs are charged against revenues in the order in which they were incurred.

The primary purpose for using an inventory cost flow assumption is to offset against revenue an appropriate cost of goods…

The three cost flow assumptions that businesses use for this are FIFO, LIFO, and the Weighted Average Cost (WAC). In a perpetual system, the inventory account changes with every transaction.

Under LIFO, the most recent purchase is assumed to be sold first and recorded to cost of goods sold. This means that the most recent cost is being recorded as an expense and recorded in the same period as the related revenue.

What are the assumptions of inventory control? ›

Inventory Control in Certain Conditions

The model has the following assumptions: There is a known, continuous, and constant demand. Costs are known and constant. Shortages are not permitted.

FIFO stands for first in, first out, an easy-to-understand inventory valuation method that assumes that the first goods purchased or produced are sold first. In theory, this means the oldest inventory gets shipped out to customers before newer inventory.