Question: An example is probably the easiest approach by which to demonstrate cost flow assumptions. Assume

a men’s retail clothing store holds $120 in cash. On October 26, Year One, one blue dress shirt is bought for

Don't use plagiarized sources. Get Your Custom Essay on
Just from $13/Page
Order Essay

$50 in cash for resell purposes. Later, near the end of the year, this style of shirt becomes especially popular. On

December 29, Year One, the store’s manager buys a second shirt exactly like the first but this time at a cost of $70.

Cash on hand has been depleted completely ($120 less $50 and $70) but the company now holds two shirts in its


Then, on December 31, Year One, a customer buys one of these two shirts by paying cash of $110. Regardless of

the cost flow assumption, the company retains one blue dress shirt in inventory at the end of the year and cash of

$110. It also reports sales revenue of $110. Those facts are not in doubt.

From an accounting perspective, two questions are left to be resolved (1) what is the cost of goods sold reported

for the one shirt that was sold and (2) what is the cost remaining in inventory for the one item still on hand?

In simpler terms, should the $50 or $70 be reclassified to cost of goods sold; should the $50 or $70 remain

in ending inventory? For financial accounting, the importance of the answers to those questions cannot be

overemphasized. What are the various cost flow assumptions and how are they applied to inventory?

Answer: SPECIFIC IDENTIFICATION. In a literal sense, specific identification is not a cost flow assumption.

Companies that use this approach are not making an assumption because they know which item was sold. By

some technique, they are able to identify the inventory conveyed to the customer and reclassify its cost to expense.

For some types of inventory, such as automobiles held by a car dealer, specific identification is relatively

easy to apply. Each vehicle tends to be somewhat unique and can be tracked through identification numbers.

Unfortunately, for many other types of inventory, no practical method exists for determining the physical flow of


Thus, if the men’s retail store maintains a system where the individual shirts are marked in some way, it will be

possible to know whether the $50 shirt or the $70 shirt was actually conveyed to the customer. That cost can be

moved from asset to expense.