Confusion Around Inventory Valuation Methods!

Why Inventory Methods Matter

Inventory valuation isn’t just a technical detail it’s a strategic decision that can impact your financial statements, tax liability, and business decisions. Yet many business owners, students, and even new accountants struggle to understand the differences between inventory methods and when to use them.

Let’s break it down clearly and simply.

Understanding FIFO, LIFO, and Weighted Average

1. FIFO (First-In, First-Out)
   Assumes the oldest inventory is sold first. This method often reflects the actual physical flow of goods.

2. LIFO (Last-In, First-Out)
   Assumes the newest inventory is sold first. This can reduce taxable income in times of rising prices but is not allowed under IFRS.

3. Weighted Average Cost
   Averages the cost of all inventory items available for sale during the period. It smooths out price fluctuations.

Examples with Numbers

Let’s say you purchase inventory as follows:

• 100 units @ $10 = $1,000
• 100 units @ $12 = $1,200
• 100 units @ $14 = $1,400
  Total: 300 units, $3,600

You sell 150 units.

• FIFO:
  100 units @ $10 + 50 units @ $12 = $1,000 + $600 = $1,600 COGS

• LIFO:
  100 units @ $14 + 50 units @ $12 = $1,400 + $600 = $2,000 COGS

• Weighted Average:
  Average cost = $3,600 / 300 = $12
  150 units @ $12 = $1,800 COGS

When to Use Each Method

• FIFO: Best when prices are stable or rising and you want higher profits on paper. Common in international reporting.
• LIFO: Useful in inflationary environments for tax savings (U.S. GAAP only).
• Weighted Average: Ideal when inventory is indistinguishable or prices fluctuate frequently.

Each method has pros and cons depending on your goals, tax strategy, financial reporting, or operational simplicity.