Inventory Accounting Methods (FIFO, LIFO, Weighted Average)

Inventory accounting methods determine how the cost of goods sold (COGS) and ending inventory are calculated. The three main methods are FIFO, LIFO, and Weighted Average Cost. Each has different implications for financial reporting and taxes.

1. FIFO (First-In, First-Out)
Concept:
The oldest inventory (first purchased) is sold first.

Formula:
COGS = Cost of oldest inventory items
Ending Inventory = Cost of most recent purchases

Example:

Purchases:

100 units @ ₹10

100 units @ ₹12

Sell 150 units → COGS = (100 × ₹10) + (50 × ₹12)

Advantages:

Ending inventory reflects current prices (more realistic balance sheet)

Preferred in periods of rising prices (lower COGS, higher profit)

Disadvantages:

Higher tax liability (due to higher profits)

Does not match current costs with current revenues

2. LIFO (Last-In, First-Out)
Concept:
The most recent inventory is sold first.

Formula:
COGS = Cost of most recent purchases
Ending Inventory = Cost of older inventory

Example:

Purchases:

100 units @ ₹10

100 units @ ₹12

Sell 150 units → COGS = (100 × ₹12) + (50 × ₹10)

Advantages:

Matches recent costs with revenues

Lower taxable income during inflation (due to higher COGS)

Disadvantages:

Ending inventory may be undervalued

Not allowed under IFRS (only used in U.S. GAAP)

3. Weighted Average Cost Method
Concept:
Average cost of all inventory is used to value both COGS and ending inventory.

Formula:
Average Cost per Unit = Total Cost of Inventory / Total Units
COGS = Units Sold × Average Cost
Ending Inventory = Units Remaining × Average Cost

Example:

Purchases:

100 units @ ₹10 = ₹1,000

100 units @ ₹12 = ₹1,200

Total = ₹2,200 for 200 units → Avg = ₹11 per unit

Sell 150 units → COGS = 150 × ₹11 = ₹1,650

Advantages:

Smoothens price fluctuations

Simple to apply

Disadvantages:

May not reflect actual cost flow

Less accurate in volatile price environments

Comparison Table
Method COGS Impact in Inflation Ending Inventory IFRS Allowed Tax Implications
FIFO Lower COGS → Higher profit High Yes Higher tax
LIFO Higher COGS → Lower profit Low No Lower tax
Weighted Avg Moderate COGS Moderate Yes Moderate impact