INVENTORY ACCOUNTING: FIFO, LIFO, Weighted Average

Inventory accounting determines how the cost of goods held for sale is measured and reported in both the balance sheet and income statement.

Common cost flow methods—FIFO, LIFO, and Weighted Average—directly affect reported profit, tax liability, and asset values.

1. What Is Inventory Accounting?

Inventory accounting covers the methods used to assign costs to inventory sold and inventory remaining at period-end. It impacts cost of goods sold (COGS), net income, and inventory valuation.

Typical types of inventory:

• Raw materials

• Work in process

• Finished goods

2. FIFO (First-In, First-Out) Method

Under FIFO, the oldest inventory costs are assigned to COGS first. The ending inventory reflects the cost of the most recent purchases.

Key features:

• Matches current sales with older (often lower) costs

• Ending inventory is valued at recent prices

Example:

Beginning inventory: 100 units @ $10

Purchased: 100 units @ $12

Sold: 120 units

COGS = (100 × $10) + (20 × $12) = $1,000 + $240 = $1,240

Ending inventory = 80 × $12 = $960

3. LIFO (Last-In, First-Out) Method

Under LIFO, the most recent inventory costs are expensed first. Ending inventory reflects the oldest purchase costs.

Key features:

• Matches current sales with recent (often higher) costs in times of inflation

• Ending inventory can be understated in rising price environments

Example:

Same data as above.COGS = (100 × $12) + (20 × $10) = $1,200 + $200 = $1,400Ending inventory = 80 × $10 = $800

Note: LIFO is permitted under US GAAP but not under IFRS.

4. Weighted Average Cost Method

All inventory costs are averaged to assign a single cost per unit.

Calculation:

Total cost of goods available ÷ Total units available

Using earlier data:

Total cost = (100 × $10) + (100 × $12) = $2,200

Total units = 200

Weighted average = $2,200 ÷ 200 = $11/unit

COGS = 120 × $11 = $1,320

Ending inventory = 80 × $11 = $880

5. Financial Statement Impact

Method	COGS (Rising Prices)	Net Income	Ending Inventory Value
FIFO	Lower	Higher	Higher
LIFO	Higher	Lower	Lower
Weighted Avg	Midpoint	Midpoint	Midpoint

Choice of method can affect:

• Reported profits and tax expense

• Inventory value on the balance sheet

• Financial ratios and comparability

6. Disclosures

Companies must disclose:

• Inventory accounting policies and methods

• Changes in method and reasons

• Inventory breakdowns (raw, WIP, finished goods)

Key take-aways

• FIFO, LIFO, and Weighted Average are primary inventory cost flow methods.

• Method choice affects profit, taxes, and asset values—especially in changing price environments.

• LIFO is not permitted under IFRS.

• Disclosures help users compare companies across industries and periods.