FIFO vs weighted average inventory valuation, with a worked example
By the OrbitPi product team · Updated · 5 min read
FIFO (first in, first out) assumes the oldest stock is sold first, so closing stock is valued at the most recent purchase prices. Weighted average cost values every unit at the average cost of the stock available. Both are permitted under the international standard IAS 2 and India’s AS 2 and Ind AS 2, none of which allow LIFO; US GAAP does permit LIFO. When prices are rising, FIFO gives a lower cost of goods sold, a higher closing stock value and a higher profit than weighted average.
Key takeaways
- IAS 2 (IFRS), India’s AS 2, Ind AS 2 and ICDS II allow FIFO and weighted average cost but not LIFO. US GAAP also permits LIFO.
- Inventories are measured at the lower of cost and net realisable value, whichever formula you use.
- Weighted average can be calculated periodically or as a moving average after each receipt.
- The same cost formula should be used for inventories of a similar nature and use.
- The formula is a valuation choice. Physical issue rules, such as earliest expiry first, can differ.
Why the cost formula matters
When you buy the same item several times at different prices, you need a rule for which cost goes out with each sale and which stays in closing stock. That rule, the cost formula, decides your cost of goods sold, your closing inventory on the balance sheet and so your gross profit.
Under IAS 2 (Inventories), the IFRS standard used in many countries, and in India under AS 2 (Valuation of Inventories), Ind AS 2 and, for income tax, Income Computation and Disclosure Standard II, the cost of interchangeable items is assigned using FIFO or the weighted average cost formula. Items that are not ordinarily interchangeable, such as custom-built goods, use specific identification.
How FIFO works
FIFO assumes the items bought or made first are sold first. Each sale takes its cost from the oldest remaining purchase layer, and closing stock is made up of the most recent layers.
How weighted average cost works
Weighted average values each unit at the average cost of all similar units available. It can be calculated in two ways.
- Periodic weighted average: total cost of opening stock and purchases for the period divided by total units available, applied to all sales in the period.
- Moving (perpetual) weighted average: the average is recalculated after every receipt, and each sale is costed at the average at that moment.
Worked example: the same month under each method
A distributor starts April with no stock of an item and records these movements.
| Date | Movement | Units | Rate (₹) | Value (₹) |
|---|---|---|---|---|
| 1 April | Purchase | 100 | 50.00 | 5,000 |
| 10 April | Purchase | 200 | 56.00 | 11,200 |
| 15 April | Sale | 150 | ||
| 25 April | Purchase | 100 | 60.00 | 6,000 |
| 30 April | Sale | 150 |
FIFO: the 15 April sale uses 100 units at ₹50 and 50 units at ₹56, costing ₹7,800. The 30 April sale uses the remaining 150 units at ₹56, costing ₹8,400. Cost of goods sold is ₹16,200 and the 100 units left are valued at ₹60, or ₹6,000.
Periodic weighted average: 400 units were available at a total cost of ₹22,200, an average of ₹55.50. Cost of goods sold is 300 × ₹55.50 = ₹16,650 and closing stock is 100 × ₹55.50 = ₹5,550.
Moving weighted average: after 10 April the average is ₹16,200 ÷ 300 = ₹54.00, so the first sale costs ₹8,100. The 150 units left (₹8,100) plus the 25 April purchase give 250 units at ₹14,100, an average of ₹56.40, so the second sale costs ₹8,460. Cost of goods sold is ₹16,560 and closing stock is 100 × ₹56.40 = ₹5,640.
FIFO vs weighted average: side-by-side results
| Method | Cost of goods sold (₹) | Closing stock (₹) | Closing rate (₹/unit) |
|---|---|---|---|
| FIFO | 16,200 | 6,000 | 60.00 |
| Moving weighted average | 16,560 | 5,640 | 56.40 |
| Periodic weighted average | 16,650 | 5,550 | 55.50 |
In every case cost of goods sold plus closing stock equals the ₹22,200 spent, so the methods only move cost between the profit and loss account and the balance sheet. With rising prices, FIFO shows ₹450 more gross profit than periodic weighted average in this example. With falling prices the effect reverses.
Which method should you use?
- FIFO suits perishable, batch-controlled or fast-moving goods, where the valuation should follow the way stock actually moves, and gives a balance sheet value close to current prices.
- Weighted average suits large volumes of identical items, such as bulk materials, where individual purchase layers have little meaning, and it smooths price swings.
- Use the same formula for inventories of a similar nature and use, and apply it consistently from year to year. A change of method is a change in accounting policy that must be justified and disclosed.
Whichever formula you use, test closing stock against net realisable value, the estimated selling price less costs to complete and sell. Slow-moving, damaged or near-expiry stock is written down where its net realisable value is below cost.
General information, not professional advice. This guide summarises the rules as we understand them on the date shown. Laws, notifications and thresholds change, and their application depends on your facts. Check the official sources below and consult a chartered accountant or tax adviser before acting on it.
How OrbitPi Inventory helps
OrbitPi Inventory costs stock with FIFO, moving average (AVCO) or standard cost, per item category and site. It does not offer LIFO, and it does not calculate one periodic weighted average for a whole month. Serial-controlled items take cost from that serial’s own layer. Landed cost and revaluation are separate value movements. Physical allocation, such as earliest expiry or a named lot, is set separately from the costing method.
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