Inventory Cost Flow Assumptions Essay

Inventory cost flow assumptions are useful in sense of their own. Regardless, it is widely used in inventory management as well as financial processes such as taxation and others. As a result, it becomes an important topic for students to study and understand. Therefore, in this sample essay, we shall discuss the topic of Inventory cost flow assumptions itself.

Moreover, we shall explore all the basic concepts surrounding the concept to better understand it. Moving on, in this essay, we shall discuss the following: first of all, we will be looking at the definition of inventory cost flow assumptions. After which we will be discussing why inventory cost flow assumptions needed and are used by the companies is. Furthermore, we shall be looking at the different methods used for assuming inventory cash flow and we’ll be looking at each method in brief.

What is inventory cost flow assumptions?

The term inventory cost flow assumptions refer to a process in which the cost of items in inventory changes from their original price i.e. when it was acquired or manufactured, to when it is being sold. As a result of this difference in cost, a uniform system is set in place. Moreover, this system helps in assigning costs to inventory as they come to the stage of being sold.

Furthermore, it is termed as assumptions because companies have to make some assumptions as to which items are sold and which items are still remaining in inventory. Therefore, it is for financial process and tax purposes so it doesn’t have to agree with the exact movement of good. As a result, assumptions don’t accurately match with the real flow of goods.

Regardless, there are some things that should be kept in mind while making these assumptions. It is that the total cost of items sold plus the cost of items still in inventory for other purposes must be equal to the actual cost of goods available.

Why are inventory cost flow assumptions needed?

In this section of the sample essay, we shall discuss why companies use the inventory cost flow assumptions. So without further adieu:

Companies use inventory cost flow assumptions as it is required to find out the ending inventory and the cost of items that are being sold. Moreover, it is also used in valuing inventory as supervising the physical flow of inventory is quite difficult. Adding to that, sometimes companies experience some difference in price paid for the same item over course of time. As a result, it becomes difficult to tell determine the value of the product when it is being sold.

The three inventory cost flow assumptions

As we discussed above, the inventory cost flow assumption is used to determine the difference between the cost of acquiring the item and the cost of it when it is sold. Moreover, now we will learn that there are three types of methods that are widely used for assuming inventory cost flow.

Moving on these three methods are as namely:

• Weighted average cost
• FIFO(first-in; first-out)
• LIFO(last-in; first-out)

So these are the three methods used for inventory cost flow assumptions. Nevertheless, we shall discuss each one of these three in brief below:

1.Weighted average cost

In this cost flow assumption, all the items of the type are seen as interchangeable, the only difference being their purchasing cost.  Moreover, in this method, all the cost differences are due to outside or external factors. These factors include likes of availability, inflation, change in market price, and so on.

Furthermore, in this method costs of all are summed up and divided by the total number of units that were bought. Adding to this, at the end of the accounting cycle, the total amount of items sold is then multiplied by the average price i.e. price per unit in order to find out the total cost of items sold and ending inventory.

2.FIFO (first-in; first-out)

The FIFO cost flow assumption is abbreviated for “first-in; first-out”. Moving on, this method focuses more on the actual flow of items in inventory, unlike weighted average cost. Moreover, it is assumed that the items purchased first are first to be sold.  Adding to that, this method seems more logical as it follows the actual flow of goods.

3.LIFO (last-in; first-out)

This method of inventory cost flow assumptions was specifically made for tax purposes. Moving on, under this method the items in inventory at the starting of the financial period is assumed to be in the ending inventory. Obviously, it is just an assumption and it doesn’t actually happen. This is because LIFO is a method that is used to defer the taxes until the beginning of inventory is sold. As a result, the lower cost of goods will provide higher income and also correspondingly higher income taxes.

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