Final answer:
The four methods used to assign costs to inventory and cost of goods sold are specific identification, FIFO, LIFO, and weighted average. Each method has distinct effects on the financial statements and is selected based on the nature of the inventory and financial reporting objectives.
Step-by-step explanation:
Inventory Costing Methods
In accounting, the four primary methods used to assign costs to inventory and cost of goods sold are:
- Specific identification
- FIFO (First-In, First-Out)
- LIFO (Last-In, First-Out)
- Weighted average
Each of these methods has a unique impact on the financial statements and can provide different insights into a firm's financial performance. For instance, the FIFO method assumes that the oldest inventory items are sold first, which may be more reflective of the actual physical flow of goods for some businesses. In contrast, the LIFO method assumes the newest inventory is sold first, which can be beneficial when prices are rising, as it can reduce taxable income. The weighted average method smooths out price fluctuations by averaging the cost of all items available for sale during a period when assigning cost of goods sold. Specific identification is used when each item in inventory can be directly identified and its cost determined, which is typical of unique or high-cost items.
Understanding the cost structure of a firm is crucial when applying these methods. This includes determining fixed cost, marginal cost, average total cost, and average variable cost, each offering its own insights into a firm's cost structure and financial performance.