Final answer:
The correct option:First In First Out (FIFO) cost
Inventory is valued at FIFO cost under FIFO method and at average cost under the average cost method. LIFO cost or specific identification cost are not associated with inventory valuation in FIFO or average cost methods. Understanding cost patterns helps firms to calculate potential profits.
Step-by-step explanation:
For companies using FIFO (First In First Out) or average cost methods to value inventory, the inventory is valued differently. Under a FIFO system, inventory is valued at the FIFO cost, meaning that the cost of the oldest inventory is used to value the items sold, while the newest inventory remains unsold on the balance sheet. In contrast, when using the average cost method, companies calculate the cost of inventory by taking the weighted average of all the goods available for sale during the period and assigning it to both the cost of goods sold and the ending inventory.
It's essential to understand that under FIFO or average cost, inventory is never valued at Last In First Out (LIFO) cost or specific identification cost. These are distinct methods from FIFO and average cost and are used in different accounting scenarios. By analyzing short-run costs in terms of total cost, fixed cost, variable cost, marginal cost, and average cost, a firm can calculate average profit and evaluate patterns of costs to determine potential profit.