ANSWER:

The 4 methods of Cost of Goods Sold you will learn are:

FIFO (FIRST in, First out) – this means you will use the OLDEST inventory first to fill orders. This also means the oldest costs will appear in Cost of Goods Sold (since this is an Expense account this also means oldest costs will appear in the Income Statement). The most recent costs are shown in the Inventory ASSET account balances and are provided on the Balance Sheet. This is an advantage because you are now reporting Inventory at the current cost which better reflects what it would cost to replace inventory if that would become necessary due to a disaster. FIFO shows the actual flow of goods…typically you will sell the oldest inventory before the newest inventory.

LIFO (Last in, First out) – this means you will use the MOST RECENT inventory first to fill orders. Cost of goods sold will reflect the current or most recent costs and are a better REPRESENTATION of matching since you are matching revenue will current costs of the inventory. The Balance Sheet will show inventory at the oldest inventory costs and may not represent current market value.

Weighted Average (also called Average Cost) – this method is best used when the prices change from purchase to purchase and you want consistency. The weighted average method smooths out price changes so you have a steady stream of cost instead of sharp increases and decreases. You will calculate a new Average Cost after each Purchase (Sales will not change the average cost).

Specific Identification – clearly, this will be your favorite method…it is the easiest to calculate in our examples because it specifically tells you which purchases inventory comes from. This is most often used for high priced inventory – think car sales for example. When a car dealership purchases a blue BMW convertible for $20,000 and later sells it for $60,000…they will want to show the EXACT cost of the BMW it sold as opposed to the cost of another car. So, specific identification exactly matches the costs of the inventory with the revenue it creates.

Explanation: