The kind of business that would use the specific identification method of inventory costing includes

The kind of business that would use the specific identification method of inventory costing includes

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The specific identification method of inventory control is useful for businesses with unique or high-priced products. Here's how to implement this method in your business.

We’ve covered several inventory management types, including, LIFO vs. FIFO and weighted average cost. We’ve also considered whether to use a perpetual or periodic inventory system.

Each of those methods are commonly used and easy to manage. The method that we’ll talk about today is not so easy to manage, though. It requires the specific tracking of every single unit purchased and sold.

Read on to learn why you may want to use this method when other methods, such as the first in, first out method, are much easier to implement.

Overview: What is the specific identification method?

The specific identification method is a way to calculate cost of goods sold and ending inventory by tracking every single unit of inventory and adjusting the balances when inventory is sold and when it is purchased.

This method is typically used by companies that sell high-ticket products or that want to very closely control inventory and track sales trends.

3 examples using the specific identification method

Let’s take a look at a few examples of the specific identification method and compare its results to those we’d achieve by using other methods.

1. Jose’s Coches

Jose’s Coches buys totaled cars at auction and then resells them after making repairs. Take a look at Jose’s inventory turn and how cost of goods sold and gross profit are calculated.

The kind of business that would use the specific identification method of inventory costing includes

Cost of goods sold is determined at the time of purchase using this method. Image source: Author

For Jose’s business, one of the more common methods of inventory management, such as weighted average cost, wouldn’t be applicable. The weighted average cost formula would use units 851, 852, and 853 to come up with an average cost for the sale of 851.

Because each item is unique and its cost has nothing to do with the others, specific identification should be used to calculate the cost and gross profit.

2. Iliana’s Island Washes

Next, let’s take a look at an example where using a common method would be feasible.

For Iliana’s car wash business, the importance of inventory management comes from tracking sales trends. She sells several different types of air fresheners that all cost about the same. Here is a typical day of sales and the purchases that built her inventory. Each unit sells for $5.

The kind of business that would use the specific identification method of inventory costing includes

Brisket is the most popular selling air freshener right now. Image source: Author

Iliana’s air freshener sales happen in bunches. Once the cream of the crop, fresh-cut grass sold just three units on our example day. Brisket, on the other hand, is driving sales at the moment.

By keeping close track of which units are selling the most each day, Iliana is able to make smart orders and accurately show the cost of each scent. The first table in the graphic shows purchases made in the week leading up to our example day and the second table shows units sold on that day.

If she had used FIFO inventory to calculate COGS and gross profit for this day of sales, she would calculate the total units sold on the day, which was 66. To get to 66 units from the purchases record, she would take the 20 vanilla and linen units and 26 of the brisket.

This is a cost of goods sold of $83.90. With sales of $330, gross profit comes in at $246.10, just a bit above the total of $243.60 using specific identification.

3. Stock sales

The most common use of specific identification is probably not applicable to your business. When trading stocks, you can use this method for tax reporting. For example, let’s say you purchased shares of a stock at four different times over a number of years.

When you decide to sell some, you could choose whichever purchase had the highest price to lower your taxes now. Of course, you will eventually have to sell some shares using the lowest price, but you can do that at a time that works best for your tax and other financial goals.

3 benefits of using the specific identification method

Here are three benefits to using the specific identification method.

1. There’s no guesswork

The key benefit is that your cost of goods sold and ending inventory numbers will always be exactly correct, as long as you are confirming with an ending inventory count to catch theft or spoilage.

You don’t have to worry about matching the number of units from this sale to different purchases because each unit has a cost assigned to it.

2. You know exactly what’s selling

If you sell different versions of similar items, like the car wash business above, your inventory management software will give you up-to-date data on which items are selling the most. That will enable you to purchase new inventory that meets your current sales trends.

3. You can track heterogeneous inventory

The average cost and LIFO methods were designed for tracking homogenous goods (think 20,000 units of the same white shirt, or 150 rolls of the same size paper). If you sell heterogeneous items that can’t be counted together, specific identification is probably the best way to manage inventory.

3 disadvantages of using the specific identification method

Here are three disadvantages to using specific identification.

1. It can take a lot of work

You will need to institute some way to track each unit. If your inventory is unique enough, that could be as easy as checking a spreadsheet. If it isn’t unique, you may need to track it with barcodes or RFID chips.

2. It’s probably not necessary

Unless you only sell a few items a year and each one has a substantially different cost, you will likely be able to very closely approximate the specific identification numbers with one of the more commonly used methods.

3. You can manipulate net income

If you’re able to choose exactly which unit to sell, and thus use in the COGS calculation for each sale, it may become tempting to purposely 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 higher income (for the bank).

Sticking to a more commonly used method takes this temptation away.

Should your small business use the specific identification method?

The answer is likely no. However, specific identification is a great tool in certain limited situations. If it suits your business, you probably realized that the minute you started reading this article.

If you run an HVAC servicing business and sell used appliances every once in a while, you should probably use specific identification. If you make custom motorcycles that are unique, you should probably use specific identification. But if you run a convenience store, use FIFO or the average cost method.

Do know much about inventory

Don’t worry if you end up using a periodic inventory system and the gross profit method to complete your books every quarter. If that’s the right way to go for your business, it will get the job done.

If you need to use the specific identification method, make sure you’re tracking correctly and do an inventory count once a month to verify your numbers.

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This article is part of a larger series on Bookkeeping.

The specific identification inventory method is an accounting method that explicitly identifies each individual unit of inventory and assigns it its actual cost. This method of inventory accounting doesn’t use assumptions like first-in, first-out (FIFO), last-in, first-out (LIFO), and the average cost methods. The cost of goods sold (COGS) and ending inventory are determined by the actual cost assigned to each physical unit of inventory.

This guide includes detail on how the specific identification inventory method works, who it’s optimal for, its highlights and drawbacks, and how to calculate ending inventory and COGS using it.

How Does the Specific Identification Method Work?

For an efficient and effective specific identification inventory system to work, your business must have a detailed inventory stock-keeping system that tracks each item of inventory separately. For instance, individual inventory items might be tracked by unique serial numbers, addresses (for real estate), or title numbers.

For every sale, you must specify the exact item of inventory that’s sold. For example, a car dealer sold a 2021 Ford Explorer with vehicle identification number (VIN) JNKCV61E09M303716. The dealer has several 2021 Ford Explorers on their lot, so records must show the cost of this specific 2021 Ford Explorer separately. When VIN JNKCV61E09M303716 is sold, the actual cost of that specific 2021 Ford Explorer is removed from inventory and placed in COGS.

What Type of Business Is Specification Identification For?

  • Vehicle dealerships: Vehicle dealers have a low volume of high-ticket items that can be tracked easily by VIN.
  • Small businesses selling consumer electronics: Large consumer electronics often have unique serial numbers that can be used for identification, making it reasonable to use specific identification. However, if the business sells a lot of identical units, it might be easier to use average cost, LIFO, or FIFO.
  • Small businesses selling unique furniture: Specific identification is very suitable for a furniture store if every unit has unique features and designs.
  • Businesses using a job order costing: In a job order costing system, goods are heterogeneous because each job has different design specifications. Since each job is different, it makes sense to use specific identification.

What Type of Business Is Specification Identification Not Right For?

  • Small to midsized retailers, grocery stores, and convenience stores: The specific identification method isn’t ideal for small-value, high-turnover items. It would be difficult and expensive to track specific units of inventory. The FIFO, LIFO, or average method is more suitable for this type of business.
  • Wholesalers: Ordering goods by bulk can be challenging to track individually. Wholesalers often order the same kind of goods in bulk, and specifically identifying them for inventory won’t yield useful information. Instead, the FIFO, LIFO, or average cost method would make it easier to account for the flow of goods.
  • Small to midsize manufacturers: Manufacturing involves a multistep process and tracking materials inventory individually would be inefficient. For manufacturers, the LIFO method is more appropriate for tax savings, especially when costs are rising.

Advantages & Disadvantages of Specific Identification Method

How To Assign Costs Under Specific Identification

Costs assigned to a unit of inventory under specific identification not only include the purchase price but also any shipping charges and other costs to bring the asset into inventory.

To illustrate how specific identification works, let’s use a car dealership to show you how we maintain simple inventory records using specific identification. We can analyze our inventory by making an Inventory Quantity Report.

On July 15, 20×1, the car dealership purchased two 2022 Ford Ranger units with VINs ending 2278 and 2332 and one 2022 Ford Super Duty with VIN ending 3921. The prices of the Ford Rangers and Ford Super Duty are $22,715 and $34,895, respectively. The sale is also subject to a total shipping insurance of $890. Total shipping costs amounted to $2,331 (excluding shipping insurance) to ship the cars in an enclosed container.

Let’s compute the unit cost of each car type:

When computing the cost of a specific unit of inventory, don’t forget to subtract discounts (if any) and add shipping insurances, shipping costs, and other costs necessary to bring the asset into inventory on the dealer’s lot. Sometimes, directly attributable costs like shipping fees are quoted as a single price. In our example above, the shipping fee is $2,331 for all three cars. Hence, we just need to allocate total shipping costs per unit purchase.

To update our inventory records, we need to create another inventory quantity report as of purchase date.

We purchased two 2022 Ford Rangers. However, we didn’t combine them in one entry since both units have unique VINs. In the specific identification method, we always record inventory purchases based on unique identifiers.

Let’s assume that the dealership sold the following Ford cars during the third quarter of 20×1.

  • On July 13, 20×1, the dealership sold a 2022 Ford Explorer with VIN ending 8952 for $47,437.
  • Only September 18, 20×1, the dealership sold a 2022 Ford Super Duty with VIN ending 3921 for $50,389.

Now that we’ve sold cars during the third quarter of 20×1, let’s make another Inventory Quantity Report as of quarter end:

We recommend updating the report every time a sale or purchase is made. In our example, ABC Dealers have a low inventory volume, so updating the report frequently won’t require a tremendous amount of work.

How To Calculate Ending Inventory Using the Specific Identification Method?

The cost of ending inventory under specific identification is the sum of all the costs assigned to inventory items that haven’t yet been sold. Because costs are assigned to specific units of inventory, no cost flow assumption is required and it’s simple to identify the costs remaining in ending inventory.

How To Calculate COGS Using the Specific Identification Method?

The COGS under the specific identification method is the sum of all the costs assigned to inventory units that were sold during the period. Similar to ending inventory, it’s very easy to determine the specific inventory units sold and to identify the cost of those units.

Bottom Line

The specific identification method is a way of tracking inventory costs without the need for cost flow assumptions. It’s an inventory costing method that suits businesses with high-value, low-volume goods. However, maintaining records can be tedious if your business doesn’t have an organized accounting and information system. Establishing one requires having an accounting software program and a synchronized system of manual records.