Accounting Methods for COGS
The accounting method chosen for Cost of Goods Sold (COGS) significantly influences how a business allocates and reports the direct costs associated with the production or acquisition of goods. The three primary methods are:
1. FIFO (First-In-First-Out): This method assumes that the first units of inventory purchased or produced are sold first. It aligns with the natural flow of inventory and is often considered more reflective of real-world scenarios.
2. LIFO (Last-In-First-Out): LIFO assumes that the last units of inventory purchased or produced are the first to be sold. This method can have tax advantages during periods of rising prices, but it may not accurately represent the actual flow of inventory.
3. Weighted Average Cost: This method calculates the average cost of all units available for sale during a specific period. It offers a compromise between FIFO and LIFO, providing a smooth-out cost that reflects the average investment in inventory.
The choice of accounting method impacts financial reporting, tax liabilities, and the valuation of inventory on the balance sheet. Different industries and business strategies may lead to the selection of one method over another.