Three Methods

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The three different inventory cost flow assumptions commonly used in commerce today are first-

in, first-out (FIFO), last-in, first-out (LIFO) and average cost. When using first-in, first-out

(FIFO) the cost of the earliest goods on hand prior to each sale is charged to cost of goods sold

(Kimmel, Weygandt, & Kieso, 2009).When prices are rising, the first-in, first-out (FIFO) method

results in lower cost of goods sold and higher net income than the average cost and the last-in,

first-out (LIFO) methods. When using last-in, first-out (LIFO) the cost of the most recent

purchase prior to sale is charged to cost of goods sold and this method results in the lowest

income taxes (because of lower taxable income). Finally, under the average cost method, a new

average cost is computed after each purchase. The inventory cost flow assumption is determined

by company management, and a company may use more than one cost flow method at a time.

The three main factors that usually have an impact on the cost flow assumption adopted by a

company are income statement effects, balance sheet effects, and tax effects. Many companies

use the last-in, first-out (LIFO) cost flow assumption because this method results in the lowest

income taxes during times of inflation but ultimately whatever method a company chooses

should be consistent from one accounting period to the next.

Reference

Kimmel, P.D., Weygandt, J. J., & Kieso, D. E. (2009). Financial accounting: Tools

for business decision making (5th ed. ). Hoboken, NJ: John VWley & Sons.

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The three different inventory cost flow assumptions commonly used in commerce today are firstin, first-out (FIFO), last-in, first-out (LIFO) and average cost. When using first-in, first-out (FIFO) the cost of the earliest goods on hand prior to each sale is charged to cost of goods sold (Kimmel, Wey ...
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