Businesses frequently employ an inventory management strategy to ensure that their stockpiles are effectively monitored. One tactic that a corporation can use to efficiently record and monitor the things in its inventory is the specific identification method. Understanding how to employ this strategy will assist you in applying it within your firm, which may assist your company in reducing expenses and increasing revenues. To assist you in better grasping this strategy, we explain the specific identification method, examine how organizations commonly utilize it, and review its benefits and drawbacks.
What Is the Specific Identification Inventory Valuation Method?
The specific identification inventory valuation method is a mechanism for tracking each individual item in an inventory from the time it enters the inventory until it departs it. This distinguishes the method from LIFO and FIFO, which group inventory together depending on when it was purchased and how much it cost.
Each item is tagged with its purchase cost and any further costs incurred until it is sold in the specific inventory method.
The specific identification method additionally necessitates the following activities from financial professionals:
- Keep track of each item. When using the specific identification method, finance professionals record each item in a company’s inventory. Depending on the size of the company, they may assign a serial number to each product or manually track them.
- Keep track of how much each item costs. When using the specific identification method, accountants may keep track of how much money the company pays for each item. Accountants might update their records to verify the data they have is valid if the company purchases inventory at a discount.
- Keep an eye on inventory changes. When a customer purchases a product, an accountant normally updates the company’s inventory record. This might assist the organization in maintaining an up-to-date understanding of the things it offers for sale.
Understanding the Specific Identification Method
When a corporation is able to identify, mark, and track each item or unit in its inventory, the specific identification method is practical and usable. While larger organizations can use electronic tags or stickers with serial numbers that can be scanned into an electronic inventory tracking system, smaller businesses that can quickly identify or count goods in their inventory are more likely to use the specific identification method.
Sometimes the process can be completed simply by an employee observing the things and noting them on a sheet of paper. In an age when technology and computer programs appear to run everything, the specific identification method is utilized similarly; however, inventory counts are kept in a database.
The cost of each acquired item must also be determined on an individual basis under the specific identification method. The cost must be easily identified with a number or other identifying attribute of the object in order to be directly associated with that item. Similarly, the object must be easily tracked, found, and available when the sale promise is made.
Inventory Identification
Even if you carry comparable product categories, the specific identification method of inventory valuation requires you to distinguish each one from the others. Some products are labeled with a specific identification number. A car dealership, for example, can utilize the vehicle identification number to inventory and track each vehicle. You can also create your own product identification system to track your products. Furthermore, by combining a digital photo with the item number, each inventory item may be readily identified. If you produce specialized orders for your customers, the materials used to make the item are assigned a unique identification number and stored separately from the rest of your inventory.
Inventory Appraisal
Each object is valued at its purchase price under the specific identification method. For example, a furniture store owner who buys three sofas creates different inventory entries for each, each with its own valuation. However, the total purchase price of all three sofas is reported on the balance sheet as a single item. If the prices of the three sofas are $300, $500, and $800, the balance sheet entry would show $1,600 as the total value of the sofa inventory.
Inventory valuation
Inventory costing systems such as first-in-first-out (FIFO) and last-in-first-out (LIFO) are not intended for non-interchangeable items. Items are added to inventory when they are purchased and withdrawn when they are sold using the specific identification method. If your company creates one-of-a-kind products for particular customers, the direct materials, direct labor, and manufacturing overhead costs are all assigned to that one product. The total acquisition or production costs are applied to the cost of products sold account.
Inventory Sales
Under the specific identification method, an inventory transaction is recorded at the actual sale price. The total amount received is deducted from cash or accounts receivable and credited to sales. Deduct the cost of goods sold and credit inventory to account for the item’s cost. As quickly as feasible, the item is deleted from the inventory list. The inventory identification number has been retired to avoid misunderstanding. To avoid confusion, new inventory is given new identification numbers.
Specific Identification Method Requirements
The following are the primary needs of a specific identification tracking system:
- You must be able to track each inventory item separately. The simplest method is to use a durable metal or paper label with a serial number. A radio frequency identification tag, on the other hand, can have a unique number that identifies the product.
- You should be able to keep track of the cost of each item separately. Each purchased item should be clearly identified in the accounting system and assigned a unique identification number.
- When an inventory item is sold, you must be able to release inventory for the specific cost connected with it.
These needs can be met with a basic accounting system, possibly as simple as an electronic spreadsheet. This indicates that a smaller organization, especially when unit volumes are modest, should find it reasonably simple to use the specific identification method.
How Does The Specific Identification Method Work?
The specific identification method can be used by an accountant to assist their organization in monitoring inventory, tracking sales, and reducing liabilities. This method is frequently used by businesses to manage expensive inventory such as vehicles, jewelry, or furniture. Using this method, accountants or inventory specialists identify the things sold by the company and subsequently update the inventory record.
Smaller firms may find the specific identification method, especially appealing because it allows them to easily track and arrange their inventory goods and expenses. This accounting tool can be used by a variety of enterprises, including:
- Art galleries
- Luxury jewelry boutiques that are family-owned and operated
- High-end furniture stores
Specific Identification Inventory Valuation Method Examples
Example 1
Assume a car dealership has 50 vehicles on the lot. Depending on the model and features, each automobile has a different dealer cost and a varied sales price. Each car is traced individually from the time it enters the lot until it is sold.
In this scenario, the advantages are obvious. The dealership’s owner receives a much more helpful stream of information on the models and features that are most popular with its customers.
Example 2
This level of detail can also be useful for tax collection. Assume an investor holds 1,000 shares of ABC, a volatile small-cap manufacturer. It consists of 400 shares purchased at $40 per share, 300 shares purchased at $60 per share, and the remaining 300 shares purchased at $20 per share.
The investor then sells 300 shares at a price of $70 each. Using the method explained above, the investor can simply match the shares sold for $70 with the most costly shares purchased (for $60 per share) at tax time. As a result, the taxable capital gains are reduced.
Benefits of a Specific Identification Method
The following benefits are provided by the specific identification method:
#1. Capital gains are offset.
The use of a specific identification method helps ensure that a corporation satisfies its tax obligations and adheres to local legislation. A corporation can reduce its overall income and thus its taxed capital gains by identifying and tracking the cost of each item. For example, if a business buys $100 on 100 things and subsequently sells each one for $5, its taxable revenue is $400.
#2. Information Consistency
This method can give firms regular inventory updates. This can assist them in determining which products are in demand, which items they may discontinue producing, and which items they may need to refill. Understanding the types of items that customers frequently purchase can also assist organizations in customizing products that are currently under production, potentially improving customer happiness. Having consistent and dependable information about your company’s performance will assist you in planning and adjusting your production and manufacturing strategy accordingly.
#3. Increases the precision of your inventory count
The specific identification method necessitates treating each item in your company’s inventory as a single item rather than grouping products by kind or price. This can help to increase the accuracy of your inventory record. Furthermore, this inventory management method can assist your organization in lowering the danger of losing inventory, improving its comprehension of sales data, and increasing overall revenues.
Drawbacks of Utilizing The Specific Identification Method
The following are three drawbacks to employing specific identification.
#1. It may necessitate a substantial amount of effort.
You’ll need to set up some sort of tracking system for each unit. If your inventory is sufficiently distinctive, it may be as simple as verifying a spreadsheet. If it isn’t unique, you may need to use barcodes or RFID chips to trace it.
#2. It is unlikely to be necessary.
Unless you only sell a few goods each year and each one has a significantly different cost, one of the more regularly used methods will most likely be able to very roughly estimate the specific identification numbers.
#3. You have the ability to modify net income.
If you have the ability to choose which unit to sell and thus use in the COGS calculation for each sale, it may become tempting to choose the most expensive unit if you want to show lower net income (for taxes), or the least expensive unit if you want to show more income (for the bank).
Sticking to a more widely utilized method eliminates this temptation.
Read Also: AVERAGE COLLECTION PERIOD: Definition, Formula, and Calculations
Is It Necessary for Your Small Business to Employ the Specific Identification Method?
The answer is almost certainly no. Specific identification, on the other hand, is a fantastic tool in some limited instances. You undoubtedly realized that the moment you started reading this post if it is relevant to your business.
If you own an HVAC service company and occasionally sell secondhand appliances, you should probably use specific identification. If you create one-of-a-kind bespoke motorcycles, you should probably employ specific identification. However, if you own a convenience store, you should use FIFO or the average cost method.
Conclusion
The fact that the specific identification method is one of the most essential methods of inventory value cannot be contested. It is often advantageous for start-ups or smaller enterprises with a lower volume of inventory and sales. It assists them in understanding where the inventory item is located, i.e. at what stage, and how much income has been generated from the sale of specific products in the inventory.
Specific Identification Method FAQs
What companies would use specific identification method?
Car dealerships, jewelry stores, art galleries, and furniture stores are examples of enterprises that use specific identification methods.
What is the major advantage and disadvantage of the specific identification method of inventory costing?
The primary advantage of this strategy is that the cost flow coincides to the actual flow of inventory. In other words, actual costs are compared to revenues. The biggest disadvantage of utilizing a specific identification method is that the net income can be readily changed.
What means FIFO?
First In First Out
FIFO signifies that the products that are stored first must be retrieved first.
