Specific identification method

This method is theoretically the most correct of all. It tracks each individual item in inventory, and when that particular item is sold, that is the item that is taken out of inventory. If you know that your 1,065 units are made up of 210 of the $12.50 units, 345 of the $13.10 units, 312 of the $12.16 units, and 198 of the $14.25 units, then your inventory is the sum of all of these: $13,759.92.

Specific identification is universally permissible, but can be difficult or impossible when there are large quantities of items to track.

Weighted average cost

This method tries to correct the inequities of FIFO and LIFO and comes up with an average cost for the year. Then, as units are sold, that average cost is applied to the income statement. In the example above, you have a total of 3,075 units that you have brought into inventory. The total cost of those units is $40,722.50. The average cost is then $40,722.50/3,075 = $13.24 per unit. You sold 2,010 units in the year, so your cost of goods sold would be $13.24 X 2,010 = $26,612.40 which would leave $14,110.10 ($40,722.50 ­$26,612.40) in inventory.

Confused yet? Inventory costing can be a very confusing topic. The good thing is that it is becoming less of an issue in the business world, in part because ease of shipping allows inventory to be shipped in a very short amount of time, so you no longer need to stockpile great loads of product. During the last 20 years, in most industries in most industrialized countries, inventory levels have been diminishing.

Just know that once you pick a costing method, you'll have clear sailing from there and never have to think about the alternative methods again!