The inventory cost flow assumption is the concept that the cost of an inventory item changes between the time it is acquired or built and the time when it is sold. Because of this cost differential, a company needs to adopt a cost flow assumption regarding how it treats the cost of goods as they move through the company.
There are a multitude of possible ways to interpret the cost
flow assumption. For example:
§ FIFO cost flow assumption. Under
thefirst in, first out method, you assume
that the first item purchased is also the first one sold. Thus, the cost of
goods sold would be $50. Since this is the lowest-cost item in the example,
profits would be highest under FIFO.
§ LIFO cost flow assumption. Under
thelast in, first out method, you assume that the
last item purchased is also the first one sold. Thus, the cost of goods sold
would be $90. Since this is the highest-cost item in the example, profits would
be lowest under LIFO.
§ Specific identification
method. Under thespecific identification method, you
can physically identify which specific items are purchased and then sold, so
the cost flow moves with the actual item sold. This is a rare situation, since
most items are not individually identifiable.
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