With the opening of a business, you have to make some necessary decisions. The decisions like the cost of the product, production cost, raw material cost, or other costs that are really necessary for the sale of the product. The inventory cost accounting method helps you to make a proper selling price for your product, depending on your services. So you have proper inventory management for your business. This would help you to know your organization’s profit or loss ratio.
If you don’t know about inventory cost accounting, then you have reached the right location. Here you will learn about inventory cost accounting and why it is necessary for business.
What is Inventory Cost Accounting?
The inventory costing accounting method is used by the organization’s accounting manager to decide the price of the product. Mainly, inventory costs include the cost of raw material used, transportation cost, storing the goods cost, or the tax rate on he goods. This is the final cost that is made by the accounting team to sell in the market. All this is recorded in the financial record of the business. Proper measurement of inventory cost is necessary to make a proper financial and taxable report of the organization. A perfect report can help the management team to take proper steps to enhance the production process.
Methods of Inventory Cost Accounting
Different businesses follow different methods for inventory cost accounting, each method having different advantages and disadvantages for the business. Try to choose the right method for your business to get proper results. Inventory accounting methods are:
- First In First Out(FIFO)
- Last In First Out(LIFO)
- Specific Identification Method
- Weighted Average Cost(WAC)
FIFO(First In First Out)
Under the FIFO(First in First Out) technique, the product that is purchased from the company will be sold first in the market. In this method, the cost of the old stock is used to set the new product price. This will help the business to properly manage its cost of goods sold percentage. Using the FIFO technic, old products will sell first, which creates space for new inventory.
FIFO is mainly used by time-dependent products such as frozen food items, ready-to-eat food, or drinks. You have to sell all the new products to protect them from expiry.
LIFO(Last In First Out)
In LIFO(Last in First Out), the new products are sold later and the old products are sold faster. This helps in selling the high-cost item first with less taxable income. LIFO is used by the oil and gas business because its price is unpredictable and keeps changing most of the time.
Because of selling the old item first, it creates an issue of a mismatch between COGS and the change in inventory. This will result in lower profit and high taxes as COGS is based on the old product, which has a low cost.
Specific Identification Method
A specific identification method is used to determine the actual cost of the product. This method is used for luxury or high-cost products. This method is very helpful for the sale of the luxury goods as it gives the COGS record separately for each item.
It is not suitable for business as it is a complex method, and it will track one item by one item, which takes a lot of time. So it cannot be used in a business where there are more number of items and fast selling is also going on.
Weighted Average Cost(WAC)
The weighted average cost calculates the COGS by taking the average cost of all goods. This is mainly followed by the business which have a lot of products but has a similar price.
It is mainly used by the vegetable shop, milk, and an egg if they have a similar price for all products.
How to choose the Inventory Cost Accounting Method for my Business?
A perfect inventory management process is really necessary to keep the cost of the goods low and ensure the quality. 4 questions can help you choose the right method for your business process.
- From which place are you trying to handle it? In the future, in which place are you planning to do business so that it can grow properly?
- How much stock is present with you now? If you’re thinking of more inventory and new advanced techniques for your business, then it will become more difficult for you.
- Do your products have a deadline like food, medicine products? Then you should make some new ideas to sell the product before the expiry of the goods.
- Have the costs of your goods changed continuously with time? It means you don’t have a constant price and technique for the production of the product. You should not use the weighted average cost for your business production process.
Which Inventory Cost Accounting Method is Best?
You must try to choose the accounting technique that is beneficial for your business, that can be easily used, and is suitable for the business process. Today, many businesses are using the first-in in first-out technique for inventory accounting as it can be easily used. It provides a lot of gross profits in the business process. For a business having a large number of products with different costs, you can use this technique. It can be useful when the price of each product varies from another. It helps to protect the new product from getting lost due to old product expiry problems.
What is the Cost of Goods Sold?
The Cost of Goods Sold (COGS) is only affected when you sell any inventory items on invoices or sales receipts. After you sell an inventory item, and when you run a Transaction Journal Report for invoices/sales receipts and then view the Sales/Accounts Receivable transactions and you will be able to see the Inventory/COGS transactions which are credited into the Inventory asset account and debited into the COGS account.
You can adjust the charges of the bills, checks, and credit cards into the Inventory asset account and COGS account. But, you can only force these on the sale of inventory that you do not have. The amount on each side of the inventory/COGS transaction is equal to the number of Items sold x the average cost of the Item.
Conclusion
Inventory cost accounting technique is really very necessary technique for the business to properly sell its product in the market. Whether you are using any kind of method, from FIFO, LIFO, SIM, or WAC, try to use it properly. So that you will not face any difficulty in your business processing.