What Is the Specific Identification Method? (Pros and Cons)
By Indeed Editorial Team
Published 23 October 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
The specific identification method is an inventory costing method, in which a company identifies and tracks each individual item in its inventory. This means that when they sell their goods, the company can determine which specific item they sold and record the cost of that item accordingly. Understanding how this method works can help you properly manage an inventory and ensure that the company makes the greatest profit possible. In this article, we explain what the method is, discuss the advantages, outline the disadvantages and answer frequently asked questions.
What is the specific identification method?
The specific identification method is an inventory cost flow assumption that assumes that the specific unit of inventory purchased is the one sold. For this method to work, businesses keep adequate records that identify each unit of inventory. It's especially important for businesses that sell unique items, such as art galleries, jewellers and antique dealers.
The main aim of the method is to track specific items of inventory. This means it's applicable when you can clearly identify an individual item. For this to work, companies use serial numbers, bar codes, radio frequency identification tags and stamped receipt dates. The specific identification tracking system has three general requirements:
to individually track the location of every inventory item
to individually track the cost of every inventory item and connect it to its unique identification number
to account for the cost of the specific amount when the company sells an inventory item
Advantages of the specific identification method
These are some advantages that companies can enjoy when using this particular method:
Higher degree of accuracy
One advantage is that the method provides a high degree of accuracy because businesses can track the cost of each specific inventory item and connect it to its unique identification number. This means they can avoid merely estimating the cost of inventory sold, as is the case with other methods.
Also, this information can help businesses make decisions about what inventory to purchase, how much to purchase and when to purchase it. For example, if a company knows that an inventory item is selling well, it may choose to purchase more of that item in the future.
More efficient management of inventory
Another advantage of the method is that it can help businesses manage their inventory more efficiently because businesses can track the location of each inventory item. This information can help businesses make decisions about where to store inventory and how to move it around. For example, if a company knows that an inventory item is selling well in one location, it may choose to also stock that item in other locations.
Increased visibility into inventory costs
The method can also help businesses increase their visibility into inventory costs since businesses can track the cost of each inventory item. This information can help businesses better understand their inventory expenses and make decisions about how to reduce those costs.
It also helps them make better decisions about their pricing, budgeting and strategic planning. For example, if a company knows that it has a high inventory cost, it may decide to raise its prices to offset those costs.
Reduced risk of losing or misplacing inventory
Another advantage of the method is that it can help businesses reduce the risk of losing or misplacing inventory, so they can track the location of each inventory item. This information can help businesses make decisions about where to store inventory and how to move it around.
It also helps prevent the chance of someone stealing an inventory item. For example, if a company knows that they're storing an item in a high-risk area, it may choose to move it to a more secure location.
Disadvantages of the specific identification method
There are also some disadvantages that companies can be aware of when using the method:
High degree of complexity
One disadvantage is that the method can be complex to implement and maintain because it requires businesses to track the cost of each inventory item. This can be a challenge for businesses that have a large and varied inventory.
Also, businesses need adequate records to identify each inventory item. This can be difficult for businesses that sell unique items or that don't have well-organised records. To overcome these obstacles, businesses can gain a clear understanding of the method and invest in adequate record-keeping systems to track their inventory.
May not be suitable for all businesses
The method may not be suitable for all business models since it requires them to track the cost of every item. This can be a challenge for businesses with a simple inventory or for those that don't sell unique items, such as if they sell in bulk or if they manufacture their products. They may find it difficult to implement and maintain this method. In these cases, another inventory valuation method, such as the first-in, first-out method or the last-in, first-out method, may be more suitable.
The method can also be time-consuming since it requires extra manual effort. This might be a disadvantage for companies that have a large and varied inventory or for companies that have limited resources and employees.
Businesses can offset this disadvantage by investing in automation and using technology to track their inventory. For example, businesses can use barcodes or radio frequency identification tags to track their inventory.
Specific identification method FAQ
These are answers to frequently asked questions about the method that can help you gain a deeper understanding of how it works:
What is the difference between this method and the first-in, first-out method?
The key difference between the specific method and the first-in, first-out method is that the specific method tracks the cost of each inventory item while the first-in, first-out method assumes that the first items customers buy are the first ones that the company sold.
For example, if a company sells 100 widgets and buys 200 more, the first-in, first-out method would say that the cost of the 100 widgets sold is the cost of the 200 widgets bought, while the specific method would track the cost of each widget individually. This difference can impact the bottom line of a company, so it's important to choose the right method for the business.
What is an example of the method?
Suppose that a company sells antique jewellery. Because it sells unique items, it uses the specific identification method to track the cost of each inventory item. This means that it assigns a cost to each piece of jewellery when it acquires it and keeps track of this information in its records. When the company sells a piece of jewellery, it uses the specific cost in its records to calculate the profit or loss from the sale.
For example, if it buys a necklace, it might give it a unique identification number through the use of a serial number. The company can then track the cost of this necklace. If it bought it for $100 and sells it for $200, its records then show a profit of $100.
How do you calculate the cost of goods sold using specific identification?
To calculate the cost of goods sold using specific identification, businesses can track the cost of each inventory item. When they sell one of their goods, businesses subtract the specific cost of the good from the selling price to calculate the profit or loss.
For example, if a company sells a piece of jewellery for $200 and it has the specific cost of that piece in their records as $100, then the business would show a profit of $100. In this way, businesses can use specific identification to get a more accurate understanding of their profits and losses.
What is the specific identification cost flow method?
The specific identification cost flow method is a variation of the specific identification method. Under this method, businesses track the cost of each inventory item but they also keep track of the order in which they acquired or sold the goods.
This information can determine the cost flow method that's most appropriate for businesses. For example, if a company buys goods in batches and sells them one at a time, then the first-in, first-out method is more appropriate. Meanwhile, if a company sells goods in the same order that it acquired them, then the specific identification cost flow method is more appropriate.
What is the specific cost basis?
The specific cost basis is the unique cost of each inventory item. You use this information to calculate the profit or loss from the sale of the item. This cost includes the purchase price of the item and any additional costs incurred to get the item ready for sale, such as shipping costs.
The specific cost basis can be different from the average cost of goods because it also considers the unique cost of each item. For example, if a company buys a piece of jewellery for $100 and spends an additional $10 to ship it, then the specific cost basis of that item is $110.
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