Professor Adams' Lecture Materials

LO8-04: Differentiate between the specific identification, FIFO, LIFO, and average cost methods used to determine the cost of ending inventory and cost of goods sold.

In the example above, which 1,500 units were sold on April 15th? Were they the units from the beginning of the year inventory or were they from the January 17th or March 22nd purchases?

Specific identification

Under the specific identification method, the costs of units sold and in ending inventory are traced back to the unique units.

This method works well with unique, expensive, low sales volume products like cars made by Ford Motor Company.

Average cost

The average cost method assumes that items sold and items in ending inventory come from a mixture of all the goods available for sale.

Periodic average cost

Perpetual average cost

In a perpetual inventory system, the average cost method is applied by computing a moving-average unit cost each time additional inventory is purchased. An example, presented two different ways, illustrates how the moving average is calculated.

First-in, first-out (FIFO)

The first-in, first-out (FIFO) method assumes that the first units purchased are the first ones sold. Let's look at the example from the top of the page again.

Periodic FIFO

Perpetual FIFO

Perpetual FIFO results in the exact same cost of goods sold and ending inventory as periodic FIFO. The only difference is that cost of goods sold and the inventory balance are calculated more frequently during the year. Illustration is given here.

Last-in, first-out (LIFO)

The last-in, first-out (LIFO) method assumes that the last units purchased are the first ones sold. It's the opposite of FIFO.

Periodic LIFO

Perpetual LIFO

Unlike, periodic and perpetual FIFO, periodic and perpetual LIFO do NOT result in the same cost of goods sold and ending inventory. If inventory costs are rising throughout the year, periodic LIFO will generally result in lower cost of ending inventory and higher cost of goods sold than when applying perpetual LIFO. Illustration is given here.

Comparison of cost flow methods

- All 3 methods are allowed under GAAP.
- A company does not need to use the same method for its entire inventory (e.g., it can use LIFO for raw materials and FIFO for other types of inventory).
- However, a company must disclose the inventory method(s) it uses.

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