What is the difference between the flow of costs and the physical flow of goods?
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The term cost flow assumptions refers to the manner in which costs are removed from a company's inventory and are reported as the cost of goods
sold. In the U.S. the cost flow assumptions include FIFO, LIFO, and average. (If specific identification is used, there is no need to make an assumption.) FIFO, LIFO, average are assumptions because the flow of costs out of inventory does not have to match the way the items
were physically removed from inventory. To illustrate, let's assume that a company has four units of the same product in its inventory. The units were purchased at increasing costs and in the following sequence: $40, $41, $43, and $44. If the company physically removes and sells the oldest unit (the unit that had a cost of $40), the cost removed from inventory and reported as the cost of goods sold (COGS) will vary depending on the cost flow
assumption: Other than a one-time change to a better cost flow assumption, the company must consistently use the same cost flow
assumption. What is the Inventory Cost Flow Assumption?The inventory cost flow assumption states that the cost of an inventory item changes from when it is acquired or built and when it is sold. Because of this cost differential, management needs a formal system for assigning costs to inventory as they transition to sellable goods. Example of the Inventory Cost Flow AssumptionFor example, ABC International buys a widget on January 1 for $50. On July 1, it buys an identical widget for $70, and on November 1 it buys yet another identical widget for $90. The products are completely interchangeable. On December 1, the company sells one of the widgets. It bought the widgets at three different prices, so what cost should it report for its cost of goods sold? There are several possible ways to interpret the cost flow assumption. For example:
Additional Inventory Cost Flow Assumption IssuesThe cost flow assumption does not necessarily match the actual flow of goods (if that were the case, most companies would use the FIFO method). Instead, it is allowable to use a cost flow assumption that varies from actual usage. For this reason, companies tend to select a cost flow assumption that either minimizes profits (in order to minimize income taxes) or maximize profits (in order to increase share value). In periods of rising materials prices, the LIFO method results in a higher cost of goods sold, lower profits, and therefore lower income taxes. In periods of declining materials prices, the FIFO method yields the same results. The cost flow assumption is a minor item when inventory costs are relatively stable over the long term, since there will be no particular difference in the cost of goods sold, no matter which cost flow assumption is used. Conversely, dramatic changes in inventory costs over time will yield a considerable difference in reported profit levels, depending on the cost flow assumption used. Thus, the accountant should be especially aware of the financial impact of the inventory cost flow assumption in periods of fluctuating costs. All of the preceding issues are of less importance if the weighted average method is used. This approach tends to yield average profit levels and average levels of taxable income over time. Note that the LIFO method is not allowed under IFRS. If this stance is adopted by other accounting frameworks in the future, it is possible that the LIFO method may not be available as a cost flow assumption. What relationship the flow of costs has with the physical flow of goods?No relationship exists between the cost flow assumption and the physical flow of goods because cost flow assumption is based on the inventory available with the company which is in the process of being manufactured and it involves the inventory methods like FIFO and LIFO, while physical flow of goods didn't have any ...
What is the flow of costs?Flow of costs refers to the manner or path in which costs move through a firm. Typically, the flow of costs is relevant with manufacturing companies whereby accountants must quantify what costs are in raw materials, work in process, finished goods inventory, and cost of goods sold.
What is the physical flow?The flows of materials, products, inventories, and other goods in logistics networks, are referred to as physical flows, the main direction of which is considered to be from the point of origin to the point of consumption.
Does the choice of cost flow method FIFO LIFO or weighted average affect the statement of cash flows?Answer and Explanation: Methods like FIFO, LIFO, and weighted average are very important factors of finance due to this these methods can affect any financial activities as well as statements. Changes in these methods can result in an increase and decrease in stock because that these methods can affect cash flow also.
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