• Illustrate the use of specific identification cost flow assumption

 

Let’s apply what we have learned about accounting so far to the following situation:

The owner of NewCo Sporting Goods wants you to analyze which cost flow assumption would be best for her store: specific identification, weighted average, FIFO, or LIFO. She wants to implement a perpetual inventory system and wants to be able to log on remotely and see exactly what the inventory levels are for any item at any moment in time, as well as to be able to assess whether any of the inventory is “walking away,” so to speak.

Let’s start our analysis by taking just one item, baseball bats, and applying the different methods one at a time.

As baseball bats are purchased, they are identified by a sticker: green for the $10 bats, red for the $12 bats, and blue for the $15 bats.

Here is the list of sales, by date and by sticker color:

And here are the purchases, by date and by sticker color:

Let’s start a worksheet and do our calculations step by step, tracking purchases, COGS, and inventory on hand for each date that something happens.

	Purchases			Cost of Goods Sold			Inventory on Hand
Date	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost
Oct 1							0	$0	$0
Oct 15	10	$10	$100				10	$10	$100

On the 1st of October, there was nothing in inventory. On the 15th, NewCo bought 10 bats at $10 each and put a green sticker on them to specifically identify the cost of the bat without revealing it to the customers. In reality, it’s unlikely that NewCo would account for baseball bats using the specific indentification method. It might track carbon fiber mountain bikes that way, when there are only a few in stock and most of them are different and high-priced items. Also, NewCo would be using bar codes (SKU codes) and not stickers. However, we’re going to stay low-tech here and color code our purchases.

JournalPage 101

Date	Description	Post. Ref.	Debit	Credit
20XX
Oct 15	Purchases		100.00
Oct 15	Freight in		0.00
Oct 15	Accounts Payable			100.00
Oct 15	To record purchase of 10 bats, free shipping

Assume the supplier offers “free shipping” which actually means the shipping costs are built into the price the vendor is charging NewCo.

A purchase updates both the general ledger (GL) and the subsidiary ledger.

	Purchases			Cost of Goods Sold			Inventory on Hand
Date	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost
Oct 1							0	$0	$0
Oct 15	10	$10	$100				10	$10	$100
Oct 29				6	$10	$60	4	$10	$40

On the 29th of October, NewCo sold six bats from the ones purchased on the 15th, and so assigned those bats a $10 cost each.

This is what we need to know to create our journal entry and to update our subsidiary ledger:

JournalPage 101

Date	Description	Post. Ref.	Debit	Credit
20–
Dec 19	Checking Account		129.60
Dec 19	Sales Taxes Payable			9.60
Dec 19	Sales Revenue			120.00
Dec 19	COGS		60.00
Dec 19	Merchandise Inventory			60.00
Dec 19	To record sale of 6 bats

 

	Purchases			Cost of Goods Sold			Inventory on Hand
Date	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost
Oct 1							0	$0	$0
Oct 15	10	$10	$100				10	$10	$100
Oct 29				6	$10	$60	4	$10	$40
Nov 15	25	$12	$300				25	$12	$300
Nov 15							4	$10	$40

On the 15th of November, NewCo bought 25 more bats at a cost of $12 each and put a red sticker on them to identify the batch. Now there are 29 bats in stock: four of the original purchase with green stickers, and now 25 more with red stickers.

You’ve seen the journal entry, so we don’t need to keep repeating that.

On the 20th of November, NewCo sold six more bats: one with a green sticker and five with a red sticker. The journal entry, as usual, records both the sale and the reduction of inventory, based on our cost records, which we will now update:

	Purchases			Cost of Goods Sold			Inventory on Hand
Date	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost
Oct 1							0	$0	$0
Oct 15	10	$10	$100				10	$10	$100
Oct 29				6	$10	$60	4	$10	$40
Nov 15	25	$12	$300				25	$12	$300
Nov 15							4	$10	$40
Nov 20				5	$12	$60	20	$12	$240
Nov 20				1	$10	$10	3	$10	$30

Just look at the last two rows now. We have 20 of the red (Nov. 15) batch left, and three of the green (Oct. 15) batch left. A test count of our stock in hand should match these numbers. So far we’ve purchased 35 bats and we’ve sold 12, so there should be 23 bats on hand in the store. Let’s assume we’ve not lost any to “shrinkage” (breakage, customer theft, or employee theft) and that our perpetual records match our physical count.

On the 15th of December, preparing for the holiday rush, we bought eight more bats, but the cost has gone up (probably due to higher demand) to $15 each. As usual, we prepare the journal entry and post it to both the GL and the subsidiary ledger.

	Purchases			Cost of Goods Sold			Inventory on Hand
Date	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost
Oct 1							0	$0	$0
Oct 15	10	$10	$100				10	$10	$100
Oct 29				6	$10	$60	4	$10	$40
Nov 15	25	$12	$300				25	$12	$300
Nov 15							4	$10	$40
Nov 20				5	$12	$60	20	$12	$240
Nov 20				1	$10	$10	3	$10	$30
Dec 15	8	$15	$120				8	$15	$120
Dec 15/span>							20	$12	$240
Dec 15							3	$10	$30

Now we have three batches of bats. We color coded this latest batch with blue stickers. We have 31 bats on hand in mid-December and we sell 19 of them on Christmas Eve, leaving 12 bats on hand as we close the doors for a couple of days off.

	Purchases			Cost of Goods Sold			Inventory on Hand
Date	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost
Oct 1							0	$0	$0
Oct 15	10	$10	$100				10	$10	$100
Oct 29				6	$10	$60	4	$10	$40
Nov 15	25	$12	$300				25	$12	$300
Nov 15							4	$10	$40
Nov 20				5	$12	$60	20	$12	$240
Nov 20				1	$10	$10	3	$10	$30
Dec 15	8	$15	$120				8	$15	$120
Dec 15							20	$12	$240
Dec 15							3	$10	$30
Dec 24				4	$15	$60	4	$15	$60
Dec 24				14	$12	$168	6	$12	$72
Dec 24				1	$10	$10	2	$10	$20

Let’s prepare the journal entry for the sale on December 24:

JournalPage 101

Date	Description	Post. Ref.	Debit	Credit
20–
Dec 24	Checking Account		410.40
Dec 24	Sales Taxes Payable			30.40
Dec 24	Sales Revenue			380.00
Dec 24	Cost of Goods Sold		238.00
Dec 24	Merchandise Inventory			238.00
Dec 24	To record sale of 19 bats

After a short break, we reopen the store for a few days and take a final inventory count on the 31st of December just after we lock the doors. Dasan, the stocking clerk, turns that count into the accounting office so they can compare the physical count to the perpetual inventory records.

Here is the final tally:

	Purchases			Cost of Goods Sold			Inventory on Hand
Date	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost	Quantity	Unit Cost	Total Cost
Oct 1							0	$0	$0
Oct 15	10	$10	$100				10	$10	$100
Oct 29				6	$10	$60	4	$10	$40
Nov 15	25	$12	$300				25	$12	$300
Nov 15							4	$10	$40
Nov 20				5	$12	$60	20	$12	$240
Nov 20				1	$10	$10	3	$10	$30
Dec 15	8	$15	$120				8	$15	$120
Dec 15							20	$12	$240
Dec 15							3	$10	$30
Dec 24				4	$15	$60	4	$15	$60
Dec 24				14	$12	$168	6	$12	$72
Dec 24				1	$10	$10	2	$10	$20
Totals	43		$520	31		$368
Ending Inventory							4	$15	$60
							6	$12	$72
							2	$10	$20
							12		$152

A quick note: this is not what their subsidiary ledger looks like. This is a learning tool only. All of these entries are being done in some kind of relational database. (QuickBooks accounting software is actually a relational database specifically designed for accounting applications, but as of 2020 it still only computes inventory using the weighted average method.)

The report the database generates would look something like this, except it would have every item in the store listed, and the total of the Inventory List (subsidiary ledger) would equal the GL control account. Remember, they HAVE to be EQUAL to each other.

Notice this system is exactly the same as if the company was using the periodic system because, under specific identification, we are assigning costs to individual units as they are sold.

Normally, this system of specific identification would be used for unique items, like luxury yachts, construction jobs, custom motorcycles, even autos and smaller boats, but not normally for baseball bats, although with the increased sophistication of our computer programs, it’s not impossible to use specific identification for a wide variety of items.