Cost Method Inventory
Businesses use various cost method inventory approaches for financial reporting that work best for their industries and product types. This may be the average cost method where the total cost of goods over a certain period are averaged to obtain a fixed number. Or, it may be calculated according to costs at the time when goods were received. In each scenario, the accountant or finance department assigns a value to goods for reporting purposes and will continue using that method year after year.
Whichever approach is used tends to adhere to general accounting standards for calculating inventory cost based on costs for overhead, shipping, labor, goods, assets, storage, etc. The costs to produce a product help to determine the margins to add to a product to ensure profitability.
Costs of goods, labor, overhead, etc. change over time, effecting the total cost to create a finished good.
Inventory Costing Strategies:
- Standard costing – the costs that should be incurred to manufacture goods are standard costs which are calculated based on cost of goods, labor and overhead.
- Lean accounting – lean accounting may track improvements over time as it is geared towards the company’s principles for trimming waste and customer satisfaction.
- Activity-based – this method of costing adds in things like employee salaries, utilities costs, etc.
- Resource consumption accounting (RCA) – this approach was developed for complex organizations. It is a system that combines German cost management with activity-based costing, focusing on resources rather than cost objects.
- Throughput – this approach determines the cost by subtracting direct material costs from the selling price.
- Marginal costing – the cost of creating a single unit in addition to other units.
Here are five examples of cost method inventory:
Retail Store: A retail store buys clothing items from suppliers at a specific cost per unit. The store maintains an inventory of these items and records the amount paid. The cost method is used to track the inventory value based on the purchase cost, plus adjustments like shipping and storage. When items sell, the cost of those sold items gets deducted from the inventory value.
Manufacturing Company: A manufacturer of electronic devices uses the cost method for inventory accounting. They purchase raw materials and components needed for production, recording them as inventory at their acquisition cost. As these items are under the manufacturing processes, the cost method is used to allocate direct and indirect production costs to the inventory. When finished goods are sold, the cost of goods sold is determined based on the accumulated costs in the inventory.
Restaurant: To serve the daily menu, a restaurant maintains an inventory of food and beverage items. The cost method is used to track the value of these items based on their purchase cost. For example, if the restaurant buys a crate of tomatoes at a specific cost, the inventory is recorded at that cost. As the restaurant uses the tomatoes in its dishes, the cost of the tomatoes is deducted from the inventory value. Any additional costs, such as spices or seasoning used in food preparation, are also included in the inventory value using the cost method.
Office Supplies: Items such as pens, paper, staplers, and other supplies used in day-to-day office operations can be accounted for using the cost method. The cost of these supplies is typically recorded as an expense when they are purchased and used.
Construction Materials: Construction companies often hold inventory of materials such as cement, steel, bricks, and other supplies needed for construction projects. The cost of these materials is recorded as inventory and is expensed as the materials are used in construction projects.
Handling Cost Method Inventory Options in SOS:
Upon initial setup of your SOS Inventory account, you will have the option to select a valuation method. You may choose from FIFO (default setting), LIFO or weighted average. If you decide at some point that you want to change your valuation method, please contact us for guidance in making the transition.
In cases where an individual product is so unique, i.e., a one-of-a-kind oil painting, the specific identification method can be the best approach. This does not apply to most manufacturers, distributors, or retailers as they tend to buy and make things in larger quantities.
A retailer might report the cost of inventory as the price paid to acquire a unit of goods whereas the manufacturer would tally the cost by the total of raw materials, labor and overhead used to create the finished good.
For companies that carry inventory, it is the single largest item on their balance sheet and that is why it is so important to maintain tight control over inventory costs, quantities and the variables that impact a business’ profitability.
Inventory valuation methods are not changed often as doing so involves a lot of paperwork with the IRS. Before determining the cost method inventory choices, knowing the pros and cons of each for your particular business is recommended.
No matter which cost method you choose, SOS Inventory will ensure you keep accurate records and will synchronize with your QuickBooks Online account for consistent reporting.
Equipped with over fifty different reporting choices, SOS Inventory makes easy work of reviewing product performance and costs to make decisions about future purchases and business upgrades.
