Question

Do physical flow and cost flows have to be the same? Why would they be different?

Answer 1

Physical flow refers to the atual sequence in which goods are physically used or sold in the operations of the business.

In contrast, cost flow refers to the association of costs with the assumed sequence in which the goods are used or sold. Four methods are commonly used to assign cost based on different cost flow assumptions:

• Specific Identification
• First in First Out ( FIFO )
• Last in First Out ( LIFO )
• Weighted Average Cost (WAC )

Under the FIFO cost flow assumption, the oldest cost ir removed from inventory and charged to COGS.

Under the LIFO cost flow assumption, the most recent cost is removed from inventory and charged to COGS.

Under the WAC cost flow assumption, the average cost is removed from inventory and charged to COGS.

All FIFO, LIFO and WAC are assumptions because the flow of costs out of inventory does not have to match the way the items were physically removed from inventory.Therefore, more often than not, the cost flow would not match with the physical flows.