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 -

Finally, a week of lingo and terms I can understand and put into my everyday verbiage! I can relate these terms to either where I work now, in healthcare, or to any place I have previously worked, including grocery stores or retail. I can also easily make it pertain to my current everyday purchases, such as gasoline.

Let's start with what these terms are measuring. These terms are all ways to keep track of the inventory a company may have on hand, and how they decide to sell the product. A business needs to be able to know and keep track of how much items/products cost, and how they will get out the door to make income/profit for the company. I think of my store, Costco. Shelves are all basic, they are set up pallet by pallet, and large boxes behind large boxes. These products are all rotated from back to front. Comparing to grocery stores, all new products are placed behind the old products. This is called rotating stock. You always want to be sure to sell the oldest product first, and the newest last. This has mostly to do with expiration dates. First in, First out (FIFO) is referring to this exact scenario. The first product I am putting out should be the first product that is out the door. By doing this, I know exactly what the cost of that box of goods was. For example, if it were a pallet of king size pillows, each pallet contained 50 pillows, and the pallet cost me $500.00, I know that I could increase my cost on each pillow to sell and make a profit. To break even, each pillow would sell for $10, but to make a profit, I can increase to $20 and make a large profit. I would sell this pallet in entirety prior to setting out another one like it. This ensures that the first product in will be the first product out the door. The money has been quickly turned over and changed into profit for the company.

I could change my marketing to Last In, First Out (LIFO), but according to Unleashed Software, this is also only recognized in the USA under the Generally Accepted Accounting Principles (GAAP) and is it is forbidden to organizations in countries following the International Financial Reporting Standards (IFRS) (Unleashed Software). LIFO has the potential to show decreased profits at financial end of year, so this may appeal to companies that are trying some fancy tax evasion. On the flip side, it also shows decreased income for your company, and that is not appealing to any investor.

Weighted average cost is used when companies are not keeping strict track of each inventoried item. If a company bought a pallet of non-perishable items such as a case of green beans and had each can priced to sell at 1.00 to make profit, but then prior to the pallet getting completely sold out, they get another shipment. This pallet has gone up in price by half, so rather than waiting to completely sell out the first pallet at 1.00 per can, they add this new pallet to it, and by adding in the new increase, they average the price per can and increase it immediately. This form averages the price of all cans together and the prices fluctuate. I feel that this may be the way fuel and gasoline companies to pricing, since we know they are not waiting for their underground gas tanks to get completely empty prior to getting filled with the new gas. Along with the new gas, comes new daily prices, thus, fluctuating the average of gasoline per gallon for our vehicles.

Specific Identification is when every single item is tracked from the minute it comes in the door until it leaves. I can relate this in part to our auction company we own. For high end products that we buy outright from people and resell, we know exactly what the expense was on that item, how much time and effort goes into cleaning up the item and how much we can resell it for. We want to make a profit for our company, and we know exactly how much that margin space leaves us. We have inventory on certain items that range from low to high cost, and it takes time to log all of the details for this type of pricing. But due to the profit margins and individuality of the product, we cannot do averaging for pricing.

I believe that Costco utilizes the FIFO method for moving products. They do not disclose the specific method they use, but they do state that "our depots receive large shipments from suppliers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distributions channels" (Jelinek). They do work with several suppliers, to not become dependent on any one certain and when a product isn't available at one, they have an alternative to select from. By using the FIFO method, they can keep their supply warehouses to a minimum. They do not need to continually store extra products. They order and sell the pallets they have, and when near gone, more are brought in for sale. Having a limited, but vast selection, the product typically sells well and is sold before they even have a payment due for purchasing from the supplier.

It would not be effective for Costco to use the LIFO as I believe the product moves too quickly off the shelves for this. Nor could they do the estimated or specific method, due to the quantity of merchandise they sell. They buy large quantities to sell large quantities. By using the FIFO method, they know the pricing, and can still offer end-of-year sales if they need to. Again, with only having a few pallets of any item to sell, this is rare for Costco.

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?