The acceptable inventory valuation methods under the U.S. Generally Accepted Accounting Principles (GAAP) are:
1. Specific Identification Method
2. First-in, First-out (FIFO)
3. Last-in, First-out (LIFO)
4. Average Cost Method
Each affects the valuation of inventory and the cost of goods differently. Specific identification method, although the most accurate method, it is not practical for large volume inventories that are of similar products. FIFO is a cash flow assumption that assumes earlier goods purchased by a company are the first ones to be sold. So the oldest items are allocated to cost of goods sold and the newer items make up the ending inventory. LIFO works the opposite way. The last items to be purchased are the first ones to be sold to customers. This results in the newer items to make up the cost of goods and older items to make up the ending inventory. Average Cost Method is a weighted average of all purchased items. Cost of goods sold and ending inventory are determined by the weighted average per cost for each unit. Depending on whether the price per unit has increased or decreased within the period, elements in the financial statements would be affected differently depending on which cash flow assumption is used. For example, when the cost per unit decreases in a reporting period the net income on the financial statement will be lower if a FIFO method is used as opposed to being higher is a LIFO is used since the newest items are lesser a cost than the older items.
Organizational leaders consider 2 elements when selecting which inventory valuation method to adopt, income taxes and net income. Neither FIFO nor LIFO can result in a higher net income while having a lower income tax. So most owners would want to report on the least-latest rule where the least amount is paid in taxes at the latest date possible. When the costs of products are