April 17, 2019

Which Inventory Costing Method is Suitable for your Business?

Naveen Shayan

LedgerMax specialist

Inventory is considered as one of most valuable assets of a business whether it is comprised of raw materials, products in process or final products. Business Managers, in this regard, are responsible to control the inventory making sure that the products or raw materials do not get expired or wasted. On the other hand, accountants in majority of small business organizations use inventory costing methods to determine the cost of sold goods. There are four different methods of inventory costing suitable in different circumstances and financial targets. Yet, it is difficult to evaluate which method is better than the other. Thus, small business owners are required to choose the best inventory costing method as per their preference for their accounting system.

1. FIFO

Commonly known as FIFO, the first in, first out technique most thoroughly estimates the purchasing cycle of the real world and matches the genuine inventory flow from buying to selling in a variety of businesses. As per this technique, the earliest expenses are allotted to the sold inventory items, irrespective of whether the sold items in the inventory were essentially bought at that cost. Thus, when items bought at the earliest cost are sold, the very next earliest cost is allotted to sales.

Example:For instance, if an organization purchases 20 desktop computers at Rs. 30,000 each and then again purchases 20 more at Rs. 25,000 each, the organization would allot the Rs. 30,000 cost to the first twenty desktop computers it sells and then start allotting the Rs. 25,000 cost

.2. LIFO

Frequently called LIFO, the last in, first out technique is the opposite of the first in, first out system, allotting the latest inventory costs to the sold items. LIFO is less applied in the real-world businesses; however, there are particular state of affairs wherein LIFO more meticulously estimates the definite inventory flow.

Example:Considering the same example we used in case of FIFO, an organization would allot the latest cost of Rs. 25,000 to the first 20 desktop computers sold, afterwards it will set off to the Rs. 30,000 cost, speculating no other purchases are made in the interim.

3. Average Cost Method

This inventory costing method allots the cost of inventory items by estimating an average of the entire purchase costs of the inventory. The average cost method is perfect for organizations that sell indestructible or durable inventory items in an inconsecutive way, for example retailers of video games. This inventory costing technique is ideal for providing a firm and dependable structure for cost recognition as compared to other techniques, estimating that costs do not blow madly for the inventory items.

Example:Taking the same example we used in the first two methods, an organization would allot an average cost of Rs. 27,500 ��� i.e.�� the sum of 30000 and 25000 divided by 2 to all the twenty desktop computers sold.

4. Specific Identification Method

This the fourth inventory costing method that flawlessly matches the units sold with the cost of inventory, allotting the definite cost of every sold item in the inventory while the particular item is sold. Specific Identification Method is not suitable for organizations that deal in selling high capacities of comparatively standardized products, for instance food manufacturers; however, this method can be perfect for organizations that sell very expensive items with comparatively less volume, for instance jewelry or automobiles

.Example:Lets take an example of an automobile showroom. When an automobile is being sold by a salesman, he forwards the particular invoice number or VIN of the automobile to the accounting department together with the sales information. This allows the accountant to find out precisely how much did the automobile cost to the showroom owner.Hence, every business organization can look up to any of these four inventory costing methods to reach their financial targets smoothly.

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