Companies use different costing methodologies based on their business models. The most common methods are: FIFO- First
Question:
Companies use different costing methodologies based on their business models. The most common methods are:
- FIFO- First In, First Out
- LIFO- Last In, Last Out
- Weighted Average
- Specific Identification
Costing Systems -
When it comes to business each model is quite different as well as the overall goals. Some businesses want to advance in quality, some financially, and others even transform into new types of business through expansion. For example, earlier on I mentioned the business Sephora. As a recap Sephora is a beauty line company which offer their own brand as well as many other brands within their stores. The other brands either change or are stationery. This business is multinational and owned by an even larger business called LVMH. LVMH is another overall owner of Sephora, who is their biggest business followed by smaller businesses. These other businesses owned by LVMH include wine and spirits, jewelry, leather goods, amongst other activities. Companies often branch out, but some simply like to advance in their specialty as is.
Regarding business models we can begin with FIFO, which simply stands for first in, first out. The idea of this method is used for cost flow assumption purposes. As items progress to later development stages and as finished inventory items are sold, the associated costs with that product must be recognized as an expense. With FIFO, the cost of inventory purchased first will be recognized first. An example, (Assume a company purchased 100 items for $10 each, then purchased 100 more items for $15 each. The company sold 60 items. Under the FIFO method, the COGS for each of the 60 items is $10/unit because the first goods purchased are the first goods sold. Of the 140 remaining items in inventory, the value of 40 items is $10/unit, and the value of 100 items is $15/unit because the inventory is assigned the most recent cost under the FIFO method.)
Another method often used in business is LIFO, last in, first out. This method is used typically for business that records the most recently produced items in a series as the ones that are sold first. This means that the cost of the most recently purchased products is the first expense as cost of goods sold (COGS). The cost of the older products (lower) will be reported as inventory. An example, (Assume company A has 10 widgets. The first five widgets cost $100 each and arrived two days ago. The last five widgets cost $200 each and arrived one day ago. Based on the LIFO method of inventory management, the last widgets in are the first ones to be sold. Seven widgets are sold, but how much can the accountant record as a cost?
Each widget has the same sales price, sorevenueis the same. But the cost of the widgets is based on the inventory method selected.
Based on the LIFO method, the last inventory in is thefirst inventorysold. This means the widgets that cost $200 sold first. The company then sold two more of the $100 widgets. In total, the cost of the widgets under the LIFO method is $1,200, or five at $200 and two at $100.
In contrast, using the FIFO method, the $100 widgets are sold first, followed by the $200 widgets. So, the cost of the widgets sold will be recorded as $900, or five at $100 and two at $200.)
Next, we have weighed the average, which is the average length of time that each dollar of unpaid principal on a loan, mortgage, or amortizing bonds remains outstanding. Often credit risk is evaluated in association with fixed income securities. The formula as follows is necessary for evaluating risk and understanding interest amongst other financial concerns associated with weighted average. (There are four steps involved in calculating an amortizing bond's WAL. Assume a bond makes one payment per year. Over the next five years, the bond's payments are $1,000, $2,000, $4,000, $6,000, and $10,000. Therefore, the total value of the (unweighted) payments before the WAL computation is $23,000. The first step of the calculation is to take each of these payments and multiply them by the number of years until the payment occurs. In this example, these values would be Year 1 = 1 x $1,000 = $1,000
Year 2 = 2 x $2,000 = $4,000
Year 3 = 3 x $4,000 = $12,000
Year 4 = 4 x $6,000 = $24,000
Year 5 = 5 x $10,000 = $50,000
The second step in the calculation is to add these weighted amounts together. In this example, the total weighted payments equal $91,000. Step three is to add up the bond's total unweighted payments. In this example, the total is $23,000. The ultimate step is to take the total weighted payments and divide this value by the total unweighted payments to get the WAL:
Weighted average life = $91,000 / $23,000 = 3.96 years)
Lastly, the specific identification method is one of the accounting methods used for valuation of the inventory where the track of every item of the inventory used in the company is kept. This method means every item sold during the period and every item that remains as part of the company's inventory is identified and assigned the cost separately. There is a formular related to this methos and necessity and the process listed as follows. (In the process, the company needs to keep track of the following:
(Individual tracking of cost- Each item manufactured or purchased needs to have a proper record of its cost, which will be unique for all in the case ofspecific identification methodfor inventory costing.
Match cost to sales- This is done while calculating the COGS. The cost and revenue are matched for each product.
Ending inventory cost- This is the last step where the remaining items are valued at their specific costs. This provides a noticeably clear and precise measure of the same.)
Earlier on I mentioned Sephora and their business practices. After understanding each method and their delviery in practice, information suggests Sephora uses the LIFO method. In the retail industry this is the most frequent practice for several reasons. Retailers may use the LIFO method for inventory valued as cost or for inventory valued under the retail inventory method (RIM). Using LIFO method in retail dollars, and increments and decrements, these are converted from retail dollars to cost using a percentage or index. Being that the biggest advantage with LIFO is the tax savings, it would make the most sense for use of Sephora. Although it is not clear, research suggests this would be an efficient way to ensure profit stability. To understand Sephora, we must understand how beauty store's function and ideally, they are full of good and various products which must be purchased in a way for efficiency. Again, COGS is a particularly crucial factor, especially in the beauty industry, as it represents the direct costs and producing or purchasing the products that the store sells. Being that Sephora branched off and sells other brands there is the packaging and shelf standing financial portion as well. There this can include raw materials, manufacturing, and labor for the products.
Overall, Sephora can benefit from either method, or each is efficient in their own way. Understanding the information, company, and style of service with Sephora (LVMH), we can presume a LIFO method is used as well as many other beauty line businesses. Some retailers may use an internally developed LIFO method for booking purposes and external developed Bureau of Labor statistics LIFO for tax purposes. Each is important without violating the LIFO conformity rule.
What is your response to what I wrote above regarding costing systems?
what key points did you take away from what I wrote above?
Are you familiar with any of the different costing methodologies I mentioned?
International Marketing And Export Management
ISBN: 9781292016924
8th Edition
Authors: Gerald Albaum , Alexander Josiassen , Edwin Duerr