by The specific identification method relates to inventory valuation, specifically keeping track of each specific item in inventory and assigning cost individually instead of grouping items together the manner of calculation that is typically done in the first in, first out (FIFO) and last in, first out (LIFO) methods.
The specific identification method is useful and usable when a company is able to identify, mark, and track each item or unit in its inventory. While the specific identification method can be utilized by larger companies with electronic tags or stickers with serial numbers that can be scanned into an electronic inventory tracking system, it is most common with smaller businesses that can easily identify or count items in their inventory.
Sometimes, the process can be done simply by an employee laying eyes on the items and marking them down on a piece of paper. In an age where technology and computer programs seem to run everything, the specific identification method is used in a similar way; however, inventory counts are recorded in a database.
Under the specific identification method, it’s also necessary that the cost of each purchased item can be determined on an individual basis. The cost must be easily associated with a number or other identifying feature of the item so that it can be directly connected to that item. Likewise, the item must be easily tracked, found, and available when the promise of sale is made.
The Pros and Cons of the Specific Identification Method
The primary drawback to the specific identification method is that its use requires a definitive ability to easily and consistently identify all the individual items within a company’s inventory, track their cost, and produce them upon sale or the promise of sale.
Both the cost of the item and the amount received for the sale of the item must be attached to a specific item with some form of a unique identifier that singles it out. The process is incredibly difficult for larger businesses such as big box stores to achieve because of the sheer volume that such companies move on a daily basis.
It is an issue that smaller businesses don’t generally face, which is why such companies are the ones that commonly utilize the specific identification method. One benefit of the method is a much higher degree of accuracy when it comes to the actual numbers of items in inventory and then, of course, a higher degree of accuracy when it comes to the numbers of dollars in earned income or profit, as well as any lost revenue if items are damaged, lost, or returned. The chances of losing or misplacing inventory under such a system are almost obliterated because of its accuracy.
Occasionally, it is used to identify specific securities. This method of identification allows investors to reduce or offset capital gains by picking a specific lot of securities to be used as the basis for a sale.
Obviously, this inventory method takes more work upfront than the alternatives. It might not be a reasonable use of time for a seller of t-shirts or candles. But it could be very useful to a seller of a wide variety of merchandise who wants a steady stream of information on what products or styles are in demand, what’s not selling, and what needs restocking.
In addition, it has practical uses in accounting. It makes it easy to calculate the ending inventory cost. That figure tells the company the total annual expenses associated with all unsold goods in its inventory. It also provides a highly accurate figure for the cost of goods sold.
Advantages
- The first and most important advantage of using the Specific identification method is that it helps the business keep track of every item of the inventory used in the company from the time such inventory comes into the business till the time it goes out of business.
- With the use of the specific identification, method cost is assigned to every item used in the company individually. In the LIFO inventory and FIFO methods, the cost is assigned to the inventory by grouping them based on specified criteria. It ensures a high degree of accuracy in the valuation of closing stock at the end of a particular period and the valuation of the cost of goods sold during the period.
Disadvantages
- As it tracks every item of the inventory used in the company from the time such inventory comes into the business until the time it goes out of business is kept, it requires lots of effort and time from the person responsible for such tracking.
- If the companies use the Specific identification method, then under those situations, the company’s net income can be manipulated easily by the company’s management.
- As the company has a vast number of transactions, it is difficult to identify the purchased products, so this method is rarely used. It is restricted to businesses dealing with high-value items.
Example
Take a retailer for example. Retailers order tons of inventory from wholesalers and manufacturers on a regular basis. Palates of goods can be delivered on a daily basis. Let’s assume an electronics retailer ordered 10 computers. Each computer is slightly different and can be identified by the serial number. The receiving department can unpack the shipment, scan each computer into the system, and assign the total invoice cost to the individual goods.
This system is extremely accurate because each piece of inventory can be tracked separately. There are no estimates involved which make the inventory and cost of goods sold numbers more accurate on the financial statements as well.
Even though this system is extremely accurate, few companies actually use it. There are two main problems with the specific identification method. The first main problem is that the system takes a lot of time and effort. Each piece of inventory must be separately scanned and entered into the system. The second reason is that most goods can’t be separately identifiable. A huge palette of homogenous goods is most like indistinguishable.
Most companies use FIFO or LIFO inventory valuation methods.
