The value assigned to ending inventory is the result of two measurements: quantity and price. Quantity is determined by taking a physical inventory. The pricing of inventory is usually based on the assumed cost flow of the goods as they are bought and sold. One of four assumptions is usually made regarding cost flow. These assumptions are represented by four inventory methods.
Inventory pricing can be determined by the specific identification method, which associates the actual cost with each item of inventory, but this method is rarely used.
The average-cost method assumes that the cost of inventory is the average cost of goods available for sale during the period.
The first-in, first-out (FIFO) method assumes that the costs of the first items acquired should be assigned to the first item sold.
The last-in, first-out (LIFO) method assumes that the costs of the last items acquired should be assigned to the first items sold.
The inventory method chosen may or may not be equivalent to the actual physical flow of goods.
