Accountancy/Cost Flow Assumptions

=Cost Flow Assumptions=
 * Cost flow assumptions affect the more important Income Statement and less important Balance Sheet
 * Assume that the most recent cost is most relevant cost

Specific Identification

 * Keeps track of the cost of each, specific good sold

The Good

 * Perfect matching of costs of goods to goods sold

The Bad

 * Often impossible or too costly
 * Allows manipulation by management

FIFO

 * First-In-First-Out
 * Assigns first costs incurred to COGS (Cost of Goods Sold) on the Income Statement

The Good

 * Disallows manipulation by management
 * Cost flow agrees with ideal, physical flow of goods
 * Counter-Argument – Agreement of cost flow and ideal, physical flow of goods is not important

The Bad

 * Uses the least relevant cost for the Income Statement
 * Underestimates or overestimates cost of goods sold if prices are rising or falling, respectively

LIFO

 * Last-In-First-Out
 * Assigns last costs incurred to COGS on the Income Statement

The Good

 * Disallows manipulation by management
 * Uses the most relevant cost for the Income Statement

The Bad

 * Underestimates or overestimates cost of goods sold if prices are falling or rising, respectively
 * Cost flow disagrees with ideal, physical flow of goods
 * Counter-Argument – Agreement of cost flow and ideal, physical flow of goods is not important

Weighted Average

 * Assigns average cost incurred to COGS on the Income Statement

The Good

 * Disallows manipulation by management
 * Better estimation of the cost of goods sold than FIFO or LIFO if prices are rising or falling

The Bad

 * Tends to ignore extreme costs of inventory
 * There is no theoretical reasoning for using this method