Final answer:
An inventory cost method should be chosen based on several factors such as the nature of the business, the type of inventory being held, and the financial goals of the company.
Step-by-step explanation:
An inventory cost method should be chosen based on several factors such as the nature of the business, the type of inventory being held, and the financial goals of the company. The main inventory cost methods include FIFO (First-In, First-Out), LIFO (Last-In, First-Out), and weighted average cost. Each method has its advantages and disadvantages.
FIFO assumes that the oldest inventory is sold first, while LIFO assumes that the most recent inventory is sold first. Weighted average cost takes into account the total cost of all inventory items divided by the total number of units. The choice of inventory cost method can impact financial statements, tax obligations, and pricing decisions.
For example, if a company wants to minimize tax liabilities, they may choose LIFO as it can reduce income during periods of rising prices. On the other hand, if a company wants to accurately reflect the flow of merchandise, FIFO may be a better choice. Ultimately, the decision should be based on careful analysis of the business's specific needs and objectives.