How Inventory (FIFO, LIFO, Weighted-Average) Appears on the Balance Sheet

Graziano Stefanelli
Oct 7
3 min read

Inventory represents goods held for sale or in production, and it is one of the most significant current assets on the balance sheet. The valuation method chosen—FIFO (First-In, First-Out), LIFO (Last-In, First-Out), or Weighted-Average—directly affects the carrying amount of inventory, cost of goods sold, and ultimately, reported profitability. Understanding how these methods influence financial reporting provides insight into management’s approach to cost measurement, inflation effects, and tax strategy.

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How inventory valuation methods work

FIFO (First-In, First-Out): Assumes the earliest goods purchased are sold first. The ending inventory is valued at the most recent costs.
LIFO (Last-In, First-Out): Assumes the latest goods purchased are sold first. The ending inventory is valued at older costs.
Weighted-Average Cost: Calculates inventory cost as the average of all units available during the period, providing a smoothing effect on price fluctuations.

Example:If a company buys 1,000 units at 10 each and 1,000 units later at 12 each, and sells 1,200 units:

FIFO ending inventory = 800 × 12 = 9,600
LIFO ending inventory = 800 × 10 = 8,000
Weighted-Average = 10,000 ÷ 2,000 = 11 average → 800 × 11 = 8,800

The choice of method affects both the balance sheet and the income statement.

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Presentation on the balance sheet

Inventory is presented as a current asset, usually after accounts receivable. The balance reflects the cost basis under the chosen valuation method, adjusted for write-downs or obsolescence when necessary.

Example:

Current Assets:
- Cash and Cash Equivalents: 250,000
- Accounts Receivable: 400,000
- Inventory (FIFO): 9,600
- Prepaid Expenses: 20,000
- Total Current Assets: 679,600

The accompanying notes disclose the valuation method used and any changes in cost assumptions from prior periods.

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Journal entries for inventory transactions

To record a purchase of goods:

Debit: Inventory 20,000
Credit: Accounts Payable 20,000

To record a sale of goods:

Debit: Cost of Goods Sold 12,000
Credit: Inventory 12,000

To write down inventory to net realizable value:

Debit: Inventory Write-Down Expense 2,000
Credit: Inventory 2,000

These entries ensure that inventory balances reflect both acquisition cost and any necessary value adjustments.

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Standards under IFRS and US GAAP

IFRS (IAS 2 – Inventories): Allows FIFO and Weighted-Average methods but prohibits LIFO. Inventory is carried at the lower of cost or net realizable value.
US GAAP (ASC 330 – Inventory): Permits FIFO, LIFO, and Weighted-Average. Inventory is measured at the lower of cost or market (LCM), with detailed disclosure required when LIFO is used.

Entities must apply the chosen method consistently and disclose any changes that materially affect comparability.

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Impact on financial performance and ratios

In periods of rising prices:

FIFO results in higher ending inventory values and lower cost of goods sold, increasing gross profit and net income.
LIFO produces lower inventory values and higher cost of goods sold, reducing taxable income but also lowering profitability.
Weighted-Average yields intermediate results, providing a more stable profit margin.

For example, during inflationary periods, FIFO enhances liquidity and profitability ratios, while LIFO strengthens cash flow by reducing taxes. Analysts adjust financial statements to ensure comparability when companies use different valuation methods.

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Disclosures required for inventory

Companies must disclose:

The cost formula (FIFO, LIFO, or Weighted-Average).
The carrying amount of inventory by classification (raw materials, work in progress, finished goods).
Any write-downs or reversals to net realizable value.
The amount of inventory pledged as collateral.

Such disclosures provide transparency about valuation assumptions and the liquidity of current assets.

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Operational considerations

Inventory accounting extends beyond compliance—it reflects the company’s operational efficiency, pricing strategy, and supply chain management. FIFO suits perishable goods and industries sensitive to quality rotation. LIFO benefits firms in inflationary environments, though it is disallowed under IFRS. Weighted-Average simplifies tracking for high-volume businesses with homogeneous products.

Effective inventory management reduces holding costs and obsolescence risk, while consistent valuation enhances comparability and credibility of financial statements.

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DATA STUDIOS

.....[datastudios.org]