Specific identification accounting is a system of inventory valuation. In this method, each item is tracked from the time it is purchased till it is finally sold. This technique is followed by the businesses that sell fewer units of an item, having high costs. It is used when the products stored as inventory have distinct features and prices.
What is Specific Identification Accounting 101?
Specific identification accounting refers to the method of finding out the inventory costs based on the cost of purchase of the goods. It is based on the movement of specific, identifiable inventory items in and out of a company’s stock. This accounting is applicable only if each item of inventory can be specifically identified or tracked from purchase to sale.
This method is often used for low-volume or high-priced items. Specific identification accounting is used to track each purchase and its respective prices individually. It provides more useful sales information when used for inventory management. Used by companies like furniture stores, vehicle dealerships, jewelry stores, art galleries, etc.
Individual tracking is the main feature that distinguishes the specific identification method from LIFO and FIFO methods. In LIFO (Last in First Out) and FIFO (First in First Out) techniques, the inventory is grouped based on the time and cost in which it was purchased.
Requirements of Specific Identification Accounting System
- The inventory items should be able to be tracked individually. The best way to do specific identification accounting is with labels. Here the products are identified with serial numbers or radio frequency identification tags (RFID tags).
- The cost of each item should be tracked separately. The cost per item that is purchased must be identified clearly in the accounting system. Then these costs should be associated with a unique identification number.
- The inventory has to be relieved for the specific costs associated with each item that is sold.
Advantages of Specific Identification Accounting
Using a specific identification accounting method for inventory management allows matching the revenue earned with the expenses incurred in respect of the company’s inventory. This means that the sales revenue is accurately matched with the cost of goods sold.
Some of the main advantages of specific identification accounting are mentioned below:
- It helps to calculate the accurate cost of inventory in the company.
- It helps to efficiently manage inventory as each product is individually tracked from the time it enters the company till the time it is sold.
- The flow of cost in a specific identification method corresponds to the actual or physical movement of the items in the inventory. This leaves little space for ambiguity.
Disadvantages of Specific Identification Accounting
The method is rarely used as there are only a few items purchased with unique identification codes, which are recorded in the company’s accounting records. This type of differentiation is usually not done for low-cost items. Most businesses sell products that are essentially interchangeable. Hence use FIFO, LIFO, and weighted average methods.
Some of the disadvantages of specific identification accounting are listed below:
- It is a time-consuming process and hence requires a lot of manual effort.
- It is a hindrance for large organizations as each item needs to be tagged with its respective costs.
- It is difficult to use this method on interchangeable goods. Because it becomes complex to attach costs like shipping and storage to certain goods.
Example of Specific Identification Accounting
Consider company XYZ as a trading company, dealing with different brands of a product. Let us think of the product as a variety of pens in the market. Following are the transactions that took place in the company during August 2021.
As per the above table, it is clear that a total of 1100 units was sold by the company during August 2021. The sold goods consist of different costs per unit i.e., ₹3.00, ₹3.10, ₹3.25, and ₹3.50 respectively.
Out of the total 1100 units of inventory the sales was as follows:
- 400 units were sold from the 1000 units purchased on 01/06/2021 at ₹3.00.
- 200 units were sold from the 500 units purchased on 16/06/2021 at ₹3.10.
- The next 200 units were sold from the 700 units purchased on 21/06/2021 at ₹3.25.
- And the last 300 units were sold from the 900 units purchased on 25/06/2021 at ₹3.50.
Calculation of closing stock at the end of August 2021
Therefore, the value of the closing stock at the end of August 2021 is ₹6455.
Calculation of the cost of goods sold for August 2021
Hence, the value of the cost of goods sold for August 2021 is ₹3520.
Main Points to Be Noted
- Under the specific identification accounting method, every item remaining as a part of the company’s inventory is identified and the corresponding costs are assigned separately.
- The cost of specific items sold during a certain period is included in the cost of goods sold during that particular period.
- The cost of goods that remains in the company’s inventory is included in its closing stock for that period.
Specific valuation accounting is a technique used for the valuation of inventory by assigning individual costs to each item rather than grouping them. This method helps the company to keep a track of every inventory item from the time it is purchased till the time it is finally sold.
Principle requirements of a specific identification accounting are as follows:
- Inventory items should be trackable individually.
- The costs of each item should be trackable.
- Inventory should be able to be relieved for specific costs associated with the stock item when it is sold.
Following are the advantages of specific valuation accounting.
- Helps to calculate the accurate cost of inventory in the company.
- Helps to manage inventory efficiently as each product is individually tracked from the time it is entered till it is out of the company.
- The flow of the cost in this method corresponds to the actual movement of the inventory item, leaving less space for uncertainty.
The disadvantages of specific identification methods are as follows.
- It is a time-consuming process and requires a lot of manual effort
- It is challenging for big companies to tag each item with its respective costs.
- Difficulty in using this method on interchangeable goods. It becomes complex to attach the shipping and storage costs of certain items.
In short, I would like to say that specific identification accounting is one of the most important tools used for the valuation of a company’s inventory. In this method, each stock item is tracked in association with its respective costs. It can be used to calculate critical items like closing stock and the cost of goods sold. This method helps to understand at which stage the inventory item is and how much revenue is received from the sales of that particular item.