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FIFO, weighted average, and LIFO methods are often used instead of specific identification for inventory valuation purposes.
Cost Flow Assumptions:
1 Merchandise is purchased from time to time according to the requirements of production. It is likely that inventories are purchased during the fiscal year in different lots and at different prices. Therefore the following two problems need to be handled.
(a) Which of the cost prices should be charged to different issues of inventory and which cost price should be charged to cost of goods sold in income statement?
(b) Which cost price should be assigned to inventory for valuation and presentation on Balance sheet.
The actual physical flow of inventory and cost flow assumption applied may be different. The specific identification of different cost prices of purchases and sales is most realistic method but it is not practical as several difficulties may encounter in actual implementation of this method. The method can be successfully applied if it is possible to separate specific items and they are easily distinguishable. In specific identification method cost of goods sold and ending inventory would be calculated as shown in the following illustration.
Assume that following transactions are made during Jan 2010
The solution discusses the best approach for entities to use in terms of inventory management.