Weighted Average vs. FIFO vs. LIFO: An Overview

When it comes time for businesses to account for their inventory, business♎es may use the following three pri💧mary accounting methodologies:

• Weighted average cost accounting
• 澳洲幸运5开奖号码历史查询:First in, first out (FIFO) accounting
• 澳洲幸运5开奖号码历史查询:Last in, first out (LIFO) accounting
  

FIFO stands for "first in, first out," where older inventory is sold before newer inventory. LIFO stands for "last in, first out," where newer inventory is sold before older inventory. Weighted average assigns an average cost of production to a specific product.

Each of these three methodologies relies on a different method of calculating both the inventory of goods and the 澳洲幸运5开奖号码历史查询:cost of goods sold. Dependi♓ng on the situation, each of these systems may be appropriate.

Weighted Average

The weighted average method, which is mainly utilized to assign the average cost of production to a given product, is most commonly employed when inventory items are so intertwined that▨ it becomes difficult to assign a specific cost to an individual unit.

This is frequently the case when the inventory items in question are identical൩ to♛ one another. Furthermore, this method assumes that a store sells all of its inventories simultaneously.

To use the weighted average model, one divides the cost of the goods that are available for sale by the number of those units still on the shelf. This calculation yields the weighted average cost per unit—a figure that can then be used to assign a cost to both ending inventory and the cost of goods soldﷺ.

First In, First Out (FIFO)

The first in, first out (FIFO) accounting method relies on a cost flow as♑sumption that remo🐻ves costs from the inventory account when an item in someone’s inventory has been purchased at varying costs over time.

When a business uses FIFO, the oldest cost of an item in an inventory will be removed first when one of those items is sold. This oldest cost will then be reported on the 澳洲幸运5开奖号码历史查询:income statement as part of the cost of goods sold.

Last In, First Out (LIFO)

The last in, first out (LIFO) accounting method assumes that the latest items bought are the first items to 💎be sold. With this accounting technique, the costs of the oldest products will be reported as inventory. It should be understood that, although LIFO matches the most recent costs with sales on the income statement, the flow of costs does not necessarily have to match the flow of the physicඣal units.

Generally sp🦋eaking, FIFO is preferable in times of rising prices, so that the costs recorded are low, an🌃d income is higher. Contrarily, LIFO is preferable in economic climates when tax rates are high because the costs assigned will be higher and income will be lower.

Weighted Average vs. FIFO vs. LIFO Example

Consider this example: Suppose you own a furniture store, and you purchase 200 chairs for $10 per unit. The next month, you buy another 300 chairs for $20 per unit. At the end of an 澳洲幸运5开奖号码历史查询:accounting period, let’s assume you sold 100 total chairs. The weighted av🀅erage costs, using both FIFO and LIFO considerations, are as follows:

• 200 chairs at $10 per chair = $2,000
• 300 chairs at $20 per chair = $6,000
• Total number of chairs = 500

Weighted Average Cost

• Cost of a chair: $8,000 ÷ 500 = $16/chair
• Cost of goods sold: $16 × 100 = $1,600
• Remaining inventory: $16 × 400 = $6,400

First In, First Out (FIFO) Cost

• Cost of goods sold: 100 chairs sold × $10 = $1,000
• Remaining inventory: (100 chairs × $10) + (300 chairs × $20) = $7,000

Last In, First Out (LIFO) Cost

• Cost of goods sold: 100 chairs sold × $20 = $2,000
• Remaining inventory: (200 chairs × $10) + (200 chairs × $20) = $6,000

The Bottom Line

There are three methods to determine the cost of goods sold and the value of inventory: weighted average cost account🎶ing; first in, first out (FIFO) accounting; and last in, first out (LIFO) accounting.

Weighted averag🌼e cost accounting calculates the average cost of all inventory units available for sale over a respective period, which is then used to determin🌄e the cost of goods sold and the value of ending inventory. This method tends to be the simplest to derive.

The FIFO method assumes that the oldest inventory units are sold first, while the LIFO method assumes that the most recent inventory units are sold first. FIFO tends to෴ reflect current market prices better. LIFO better matches current costs with revenue and provides a hedge against inflation.

Choosing among weighted average cost, FIFO, or LIFO can have a significant impact on a business’s ♊balance sheet and income statement.🍌 Businesses would select any method based on the nature of the business, the industry in which the business is operating, and market conditions.

Decisions such as selecting an inventory accounting method can help businesses make key decisions in relation to the pricing of products, purchasing of goods, and the nature of their productiꦓon lines. Inventory costing remains a critical component in managing a business’s finances.