FIFO vs weighted average: inventory valuation with examples

FIFO (first in, first out) assumes the oldest units are sold first, so the stock left on hand carries the newest purchase costs. Weighted average spreads cost evenly over every unit. Both are allowed under IFRS (IAS 2). LIFO (last in, first out) is not allowed under IFRS, although US GAAP permits it.

Average unit cost = total cost of units available ÷ units available

The method you choose changes cost of goods sold (COGS), the value of closing stock and your profit, but not the cash you paid your suppliers. One example with rising prices runs through this whole guide.

FIFO vs weighted average at a glance

Over the life of the stock, both methods charge the same total cost to the income statement. They differ only in how much lands in this period's COGS and how much stays in inventory on the balance sheet.

Worked example: FIFO, weighted average and LIFO

A shop sells one product, and its purchase price rises during the month:

During the month the shop sells 250 units, so 150 are left. Each method answers the same question: how much of the €5,100.00 becomes COGS, and how much stays in stock?

FIFO

The 250 units sold come from the oldest layers first:

• 100 units of opening stock × €10.00 = €1,000.00
• 150 units of purchase 1 × €13.00 = €1,950.00
• COGS = €2,950.00

The 150 units left are the newest ones: 50 × €13.00 + 100 × €15.00 = €650.00 + €1,500.00 = €2,150.00.

Weighted average (periodic)

• Average unit cost = €5,100.00 ÷ 400 = €12.75
• COGS = 250 × €12.75 = €3,187.50
• Closing inventory = 150 × €12.75 = €1,912.50

LIFO, for contrast only

LIFO takes the newest units first: 100 × €15.00 + 150 × €13.00 = €3,450.00 of COGS, leaving 50 × €13.00 + 100 × €10.00 = €1,650.00 in stock. It appears here only to show why the debate exists; under IFRS you cannot use it.

The results side by side

Assume every unit sold for €20.00, so sales are 250 × €20.00 = €5,000.00.

Every method splits the same €5,100.00. If your own figures do not add back to the total cost available, a movement is missing or has been posted twice.

Moving average: a sale between purchases

Systems that update stock after every movement (a perpetual inventory) recalculate the average after each receipt. Suppose the 250 units were sold after purchase 1 but before purchase 2:

COGS is €3,000.00 and closing inventory €2,100.00, again €5,100.00 in total. The sale absorbed none of the €15.00 units because they had not arrived yet. FIFO gives the same answer (€2,950.00 and €2,150.00) whether you calculate after each movement or at the end of the period; the average does not.

How the method changes profit and taxes

In the example, FIFO reports €237.50 more gross profit than weighted average (€2,050.00 − €1,812.50) on exactly the same purchases and sales. The pattern holds in general:

• Rising prices: FIFO gives the lowest COGS, the highest profit and the highest stock value. Where taxable profit follows accounting profit, it also gives the highest taxable profit for the period.
• Falling prices: the effect reverses, and FIFO gives the lowest profit.
• Weighted average sits in between and smooths price swings, because each purchase is blended into one cost.
• Over time the differences even out. The method decides when a cost reaches the income statement, not how much the goods cost you.

The method also moves your gross margin: 41% under FIFO (€2,050.00 ÷ €5,000.00) against 36.25% under weighted average (€1,812.50 ÷ €5,000.00). When you set prices from margins, compare like with like; see margin vs markup.

Which method should you choose?

IAS 2 allows FIFO or weighted average for items that are ordinarily interchangeable. Items that are not, such as a car with its own chassis number or a machine built to order, use specific identification: each sale carries the cost of that exact unit.

1. 1Separate unique items. Value anything you track unit by unit with specific identification.
2. 2Use one formula for similar goods. IAS 2 requires the same cost formula for all inventories of a similar nature and use. Different groups, such as raw materials and goods for resale, may use different formulas, but a different location is not reason enough on its own.
3. 3Match how the goods behave. FIFO suits goods with expiry dates or quickly changing prices. Weighted average suits goods that are mixed together and cannot be told apart, such as fuel in a tank or screws in a bin.
4. 4Check the rules that apply to you. Many small businesses report under national accounting rules rather than full IFRS, and tax rules may limit the choice. Confirm it with your accountant.
5. 5Stay consistent. Apply the formula every period. Switching is a change in accounting policy: it needs a good reason and must be explained in the financial statements.

What belongs in inventory cost under IAS 2

Under IAS 2, the cost of inventories includes the costs of purchase, the costs of conversion for goods you make, and other costs of bringing the goods to their present location and condition.

This is how the €13.00 unit cost of purchase 1 is built up:

Lower of cost and net realisable value

Inventory is measured at the lower of cost and net realisable value (NRV): the estimated selling price less the estimated costs to complete and sell. Review slow-moving, damaged and out-of-date stock at least at every period end. If 10 of the €15.00 units are scratched and will sell for €12.00 with €2.00 of selling costs each, NRV is €10.00 and you write down 10 × (€15.00 − €10.00) = €50.00 as an expense. If the value recovers later, the write-down is reversed, but never above the original cost.

Landed costs that arrive after the goods

Freight, insurance, customs and broker invoices often arrive days or weeks after the goods, sometimes after part of them has been sold. The cost still belongs to those goods:

1. 1Find the receipt the invoice relates to and the units it covered.
2. 2Spread the cost over those units: by quantity for a single product, or by value, weight or volume when several products share a shipment.
3. 3Add the share of the units still in stock to inventory, which raises their unit cost.
4. 4Charge the share of the units already sold to COGS.

Example: the carrier's €300.00 freight invoice for purchase 1 (200 units, so €1.50 per unit) arrives after the sale of 250 units. Under FIFO, 150 units of purchase 1 have been sold and 50 are still in stock.

The 50 units left now cost €13.00 + €1.50 = €14.50 each, or €725.00 in total. Closing inventory becomes €725.00 + €1,500.00 = €2,225.00 and COGS €2,950.00 + €225.00 = €3,175.00. Together they make €5,400.00: the original €5,100.00 plus the €300.00 of freight.

Freight you know about but have not been invoiced for by month end should be accrued; the month-end close checklist covers that step.

Common mistakes

1. 1Valuing stock at selling price. Inventory is carried at cost, or at a lower NRV, never at the price you hope to get.
2. 2Booking landed costs as overheads. Freight and import duties left in general expenses understate inventory and distort product margins.
3. 3Putting reclaimable VAT or storage into cost. Both stay outside inventory.
4. 4Switching methods to manage profit. Results stop being comparable, and a change of formula needs a justified change in accounting policy.
5. 5Using different formulas for similar goods. Items of a similar nature and use share one formula, wherever they are stored.
6. 6Skipping write-downs. Damaged, expired and slow-moving stock must be written down to NRV.
7. 7Never reconciling to a count. A valuation is only as good as the quantities behind it, so compare the books with regular stock counts.

How Clientlly helps

Clientlly values stock with FIFO: every receipt creates a cost layer per warehouse, sales, deliveries, write-offs and transfers use the oldest layers first, and a transfer keeps the receipt's cost. Stock value is the FIFO cost of the units available, never the selling price. Landed costs such as freight, insurance, broker fees, customs duties and import taxes are capitalised and allocated across the stock lines by value, weight, volume or quantity; one that arrives after receipt goes onto the units still in stock, and the share of units already sold goes to cost of goods sold. The product's displayed cost price follows a weighted average of receipts, and inventory valuation and margin reports, cycle counts and stock reconciliation are part of the same inventory module.