Flow Of Costs

Flow of costs refers to the manner or path in which costs move through a firm. Typically, the flow of costs is relevant to a manufacturing environment where accountants must quantify what costs are in raw materials, work in process, finished goods inventory and cost of goods sold. Flow of costs does not only apply to inventory, but also to factors in other processes to which a cost is attached such as labor and overhead.

There are several methods for accounting for the flow of costs. These include LIFO (last in, first out), FIFO (first in, first out), specific identification and weighted-average cost. U.S. GAAP financial reporting standards require that companies that use the LIFO method report the difference between that method and FIFO in a line item called LIFO reserve. This allows analysts to readily compare firms using different cost flow assumptions.

For example, XYZ Corp produces widgets. It has to purchase raw goods to manufacture the widgets, which marks the start of the cost for widget production. Next, there are the costs to pay the people to run the widget press which adds on to the cost of the raw materials and the cost to operate the machines and the cost of the building where the machines are located. All of these things are accounted for in the flow of costs.