Inventory Costing Methods

At first blush, it may seem silly to have to discuss how inventory is costed. It is clearly valued at the actual cost of purchase, including shipping and freight, duty, and insurance. However, a problem arises when many of the same goods are purchased throughout the year at different prices. Which of those are considered to be the ones sold during the year?

Let's say you made purchases of Product A throughout the year as follows:

• 500 units on January 15 at $12.50/unit (total: $6,250)

• 1,250 units on April 10 for $13.10/unit (total: $16,375)

• 375 units on July 29 for $12.16/unit (total: $4,560)

• 950 units on November 12 for $14.25/unit (total: $13,537.50)

You know, therefore, that you've increased your inventory over the year by 3,075 units for a total cost of $40,722.50 ($6,250 + 516,375 + $4,560 + $13,537.50).

Let's assume that this is your first year in business and you started with no inventory. Let's also assume that you sold 2,010 of your 3,075 units during the year. Your ending inventory then is dearly 1,065 units (3,075 - 2,010). But what cost do you assign to these 1,065 units?

There are four major methods used to cost inventory flows: specific-identification; first-in, first-out; last-in, first-out; and weighted average cost. Each method has rules about when it should be applied.