Final answer:
The three primary methods used to calculate COGS are FIFO, LIFO, and Weighted Average, and each influences financial statements differently. Knowing the difference between these methods alongside understanding the breakdown of total costs provides a comprehensive insight into a firm's costing structure and potential profitability.
Step-by-step explanation:
Organizations employ various methods to calculate the cost of goods sold (COGS), which plays a critical role in financial reporting and decision-making. The three primary methods commonly used are First In, First Out (FIFO), Last In, First Out (LIFO), and Weighted Average. Though not a method for calculating COGS itself, understanding alternative measures of costs such as fixed cost, marginal cost, average total cost, and average variable cost can provide valuable insights into the firm's expenses at various levels of production.
The FIFO method assumes that the oldest inventory items are sold first, which can be beneficial in times of rising prices. Conversely, the LIFO method assumes the newest inventory items are sold first, often applied to anticipate inflation. The Weighted Average method calculates COGS by averaging the cost of goods available for sale during the period, which mitigates the effects of price fluctuations over time.
Each of these methods impacts a company's financial statements differently and understanding them is essential. For instance, during periods of inflation, LIFO typically results in higher COGS and lower profits, which can affect tax liabilities. When average cost of production is lower than market price, businesses typically earn profits, indicating effective cost management.