Inventory Valuation Methods - FIFO, LIFO, WAC Difference (2023)

Contents

  • FIFO (First-In-First-Out)
  • LIFO (Last-In-Last-Out)
  • WAC (Weighted Average Cost)
  • Inventory valuation with Leafio

Inventory is the main and most important asset of any business. Balanced inventory management secures sales, profits, warehouse and logistics processes, customer order fulfillment, and staff productivity. Overall retail business performance greatly depends on its ability to count, classify, and manage inventory.

Inventory valuation is a process of estimating the monetary value of the items found on a company’s balance sheet at the end of each financial period. Inventory valuation accuracy has a direct impact on a company’s financial statements and performance indicators.

Methods of inventory valuation

There are different ways and methods that help companies to manage their inventory balance sheets. Basically, there are three most popular and widely-used methods of inventory valuation:

  • FIFO (First-In-First-Out);
  • LIFO (Last-In-Last-Out);
  • WAC (Weighted Average Cost).

All these methods have their specific features, their pros and cons.

How to choose inventory valuation method?

The choice of method usually depends on the nature of goods and the region you are operating in.

Accounting standards and principles vary – for example, businesses in the USA work under GAAP (Generally Accepted Accounting Principles), while the majority of other countries operate under IFRS (International Financial Reporting Standards). This is an important factor to consider, as the LIFO inventory valuation method is not accepted by the regulations of the IFRS.

Related:Building an effective organizational structure for inventory management

Another very important thing to remember – financial reporting allows the use of a single valuation method, so switching or combining them isn’t possible.

First of all, consider the accounting standards and regulations accepted in your region. Second, consider the nature and type of your products. And remember, once you have chosen the method, you will not be able to choose another one or combine them.

FIFO method: definition, pros/cons and examples

First-In-First-Out (FIFO) method of inventory valuation is easy, accurate and quite logical: it is based on the assumption that the products which are purchased from the supplier (or produced) earlier are sold first. So, FIFO method takes the cost of the oldest inventory as a basis of COGS (Cost of Goods Sold) formula.

(Video) FIFO vs. LIFO vs. Weighted Average Cost

In retail, COGS is a main performance indicator, that calculates all the direct costs associated with your products sale (storage, shipping, customs clearance, store rental etc.) COGS does not include indirect expenses, such as marketing or advertising, staff salaries etc. The formula of COGS calculation is pretty simple: Cost of Goods Sold = Beginning Inventory + Direct Expenses – Ending Inventory. As a retailer you must always remember that the higher your COGS is, the less money you make

If a company uses FIFO as a primary inventory valuation method, it has to understand that the goods that arrived earlier from the supplier (or manufacturer) may sometimes be cheaper than the newer ones. It depends on the supplier’s pricing strategy, but usually, the prices tend to rise rather than fall. So, in this case, COGS will be lower and profit figures will be higher. That will result in a higher base for taxation.

In addition to being easy to manage and understandable, the FIFO method helps retailers to cut waste and spoiled goods quantities, as you always sell the older inventory first. That is why the FIFO method is so popular among businesses dealing with fast-spoiling goods, such as fresh milk, vegetables, meat, eggs, fruits, etc.

One of the biggest and most considerable disadvantages of the FIFO inventory valuation method is a high level of dependence on prices. In the case of inflation, the base of taxable income may rise dramatically and distort financial performance.

How to calculate inventory value using FIFO method?

Disclaimer: This example is only used for illustration, as milk and dairy products can be spoiled, and therefore such products can not be stored for too long.

In January a village grocery purchased fresh milk -at first, 100 bottles of full-fat milk, 1$ per bottle and then, 200 bottles of same full-fat milk from another manufacturer, 2$ per bottle.

By the end of January, 50 bottles of milk were sold.

So, using FIFO we calculate the cost of goods sold for the first batch of milk. We take the FIFO product price and multiply it by the number of products sold.

Cost of Goods Sold = 1$ x 50pc = 50$

(Video) FA31 - Inventory - FIFO, LIFO, Weighted Average Explained

We have another 50 bottles of milk on the shelves and 200 bottles of full-fat milk from another manufacturer. Let’s calculate the inventory value:

Inventory value in January = (1$ x 50pc) + ( 2$ x 200pc) = 450$

LIFO method: definition, pros/cons and examples

The Last-In-Last-Out method is the opposite to FIFO. It assumes that the most recent products are sold first. Under the LIFO method, the inventory that was acquired first remains on the company’s balance sheet while the newer items are being sold. The LIFO method is used in the US, as it is acceptable under the GAAP regulations.

If a company uses LIFO as a reference inventory valuation method, it eventually has higher COGS but lower profit and taxable income indicators. When a company uses the Last-In-Last-Out inventory valuation method, the earnings and financial statements shown are lower and the taxable income is less. This may be good when the time to pay taxes comes, but, on the other side, it may present the company as a less reliable contractor and lower the chances of getting investor or credit funding.

How to calculate inventory value using the LIFO method?

Disclaimer: This example is only used for illustration, as milk and dairy products can be spoiled, and therefore such products can not be stored for too long.

Let’s continue using a grocery store example, and let’s calculate the end of January’s inventory value using LIFO.

So, we take 200 bottles of full-fat milk we purchased later at the price of 2$ per bottle. 50 bottles were sold, as we know.

So, using LIFO we calculate the cost of goods sold for the second batch of milk.

Cost of Goods Sold = 2$ x 50 = 100$

And the 100 bottles of milk purchased at the beginning of the months (1$ each) are still unsold. 150 bottles of milk (2$ each) are also unsold. So, let’s calculate the inventory value in January:

(Video) Which are different Inventory Valuation Methods? | FIFO | LIFO | WAC | Explained with Example |

Inventory value = (1$ x 100) + (2$ x 150) = 400$

WAC method: definition, pros/cons and examples

The WAC inventory valuation method stands for Weighted Average Cost. Under the WAC method, a retailer estimates a weighted average by dividing the COGS by the number of items available. So, the retailer can then have the actual picture of inventory available on hand, an average between the newest and oldest products.

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WAC inventory valuation method is basic and simple and is sometimes referred to as a starting point for retail business. WAC deals with simple similar items, that are easy to track. The calculations are easy and you do not have to invest time and money into sophisticated accounting and record tracking systems, or hire a lot of people.

On the contrary, if you use the WAC valuation and your products belong to different price categories, you can lose money by taking the average price as a reference point and blurring the difference between expensive and cheap goods.

How to calculate inventory value using the WAC method?

Disclaimer: This example is only used for illustration, as milk and dairy products can be spoiled, and therefore such products can not be stored for too long.

Let’s illustrate using the same example. All in all, grocery store bought 300 bottles of milk (100pc+200pc) and paid 500$ (100$ + 400$).

Here comes the weighted average cost.

WAC = 500 / 300 = 1.66$ per bottle.

(Video) Inventory Valuation Methods: FIFO, LIFO, Weighted Average

At the end of the month we have sold 50 bottles, so the COGC = 50pc x 1.66$ = 83$

Inventory value = 250 x 1.66 = 415$


Regardless of the inventory valuation method chosen, real-time data records and accurate calculations is a must-have. Keeping detailed spreadsheets for each SKU can be ineffective and time-consuming, especially for large retailers that own dozens, hundreds and thousands of SKUs across several locations and sales outlets. We recommend using more sophisticated automated software which can accommodate any valuation method you choose, keep your calculations up-to-date, and take care of all your business needs.

INVENTORY VALUATION IS EASY WITH LEAFIO

We propose the Leafio Inventory Optimization Solution based on our customers' years of experience in different retail areas. We have analyzed all the weaknesses of the business and created the most effective inventory management system.

This cloud-based solution will help you to identify areas that require special attention quickly and accurately. This will help streamline ordering and delivering in the shortest possible time, which will lead to the successful implementation of the company's subsequent development strategy.

Visually pleasing business intelligence modules create transparency for every aspect of the replenishment process: from demand forecast and supplier management to chain-wide inventory performance. Making strategic data-driven decisions is now easier than ever before.

Inventory Valuation Methods - FIFO, LIFO, WAC Difference (1)

Strategic dashboard in Leafio Inventory Optimization system

The system has a powerful BI module with dozens of reports - inventory costs, sales, overstocks, lost sales, inventory turnover, and service level. These and many other specific inventory management issues are deeply and visually analyzed in Leafio inventory optimization. We offer not just a set of reports. Our analytics module is the key takeaway from our many year's supply chain experience.

Inventory Valuation Methods - FIFO, LIFO, WAC Difference (2)

Lost sales for the set period report in Leafio Inventory Optimization system

Besides, with the Leafio Inventory system, you can minimize the human error factor in the inventory process. Read also what effects our client Aversi achieved by implementing Leafio Inventory Optimization Solution.

(Video) Comparing the Inventory Valuation Methods. FIFO, LIFO, Average

FAQs

What is the difference between FIFO and LIFO method of inventory valuation? ›

The Last-In, First-Out (LIFO) method assumes that the last unit to arrive in inventory or more recent is sold first. The First-In, First-Out (FIFO) method assumes that the oldest unit of inventory is the sold first.

What is FIFO LIFO and WAC? ›

Basically, there are three most popular and widely-used methods of inventory valuation: FIFO (First-In-First-Out); LIFO (Last-In-Last-Out); WAC (Weighted Average Cost).

What is the difference between FIFO and WAC? ›

The key difference between FIFO and weighted average is that FIFO is an inventory valuation method where the first purchased goods are sold first whereas weighted average method uses the average inventory levels to calculate inventory value.

What are the 3 inventory valuation methods? ›

What are the different inventory valuation methods? There are three methods for inventory valuation: FIFO (First In, First Out), LIFO (Last In, First Out), and WAC (Weighted Average Cost). In FIFO, you assume that the first items purchased are the first to leave the warehouse.

Which inventory valuation method is best? ›

Top inventory valuation methods
  1. WAC (weighted average cost) The WAC method of inventory valuation uses a weighted average to determine the amount that goes into COGS and inventory. ...
  2. Specific identification method. ...
  3. FIFO (first-in, first-out) ...
  4. LIFO (last-in, first-out)
17 Jul 2020

Is the FIFO method the most accurate method for inventory valuation? ›

The obvious advantage of FIFO is that it's the most widely used method of valuing inventory globally. It is also the most accurate method of aligning the expected cost flow with the actual flow of goods which offers businesses a truer picture of inventory costs.

What is WAC inventory method? ›

What is the weighted average cost (WAC) method? The weighted average cost method calculates the average cost of your inventory, per unit. You can calculate WAC by dividing your cost of goods sold (COGS) by the total number of units in your inventory.

What is WAC in inventory valuation? ›

What is Weighted Average Cost (WAC)? In accounting, the Weighted Average Cost (WAC) method of inventory valuation uses a weighted average to determine the amount that goes into COGS and inventory. The weighted average cost method divides the cost of goods available for sale by the number of units available for sale.

What is FIFO formula? ›

To calculate FIFO (First-In, First Out) determine the cost of your oldest inventory and multiply that cost by the amount of inventory sold, whereas to calculate LIFO (Last-in, First-Out) determine the cost of your most recent inventory and multiply it by the amount of inventory sold.

Is FIFO the best method? ›

FIFO is an ideal valuation method for businesses that must impress investors – until the higher tax liability is considered. Because FIFO results in a lower recorded cost per unit, it also records a higher level of pretax earnings. And with higher profits, companies will likewise face higher taxes.

Why is FIFO method better? ›

FIFO is more likely to give accurate results. This is because calculating profit from stock is more straightforward, meaning your financial statements are easy to update, as well as saving both time and money. It also means that old stock does not get re-counted or left for so long it becomes unusable.

Is food a LIFO or FIFO? ›

Foods kept frozen will remain safe, but can lose their quality over time. A great system to help with this is “FIFO.” FIFO is “first in first out” and simply means you need to label your food with the dates you store them, and put the older foods in front or on top so that you use them first.

What are the 4 methods of inventory? ›

There are four accepted methods of inventory valuation.
  • Specific Identification.
  • First-In, First-Out (FIFO)
  • Last-In, First-Out (LIFO)
  • Weighted Average Cost.

What are the 3 types of inventory? ›

There are three general categories of inventory, including raw materials (any supplies that are used to produce finished goods), work-in-progress (WIP), and finished goods or those that are ready for sale.

What are the 4 main valuation methods? ›

4 Most Common Business Valuation Methods
  • Discounted Cash Flow (DCF) Analysis.
  • Multiples Method.
  • Market Valuation.
  • Comparable Transactions Method.

What is the most popular valuation method? ›

The three most common valuation methods are: DCF analysis, comparable company analysis and precedent transactions.

What is the most commonly used inventory method? ›

First-In, First-Out (FIFO)

The FIFO valuation method is the most commonly used inventory valuation method as most of the companies sell their products in the same order in which they purchase it.

What is WAC per unit? ›

WAC per unit = Cost of Goods Sold ÷ Units available for sale. The weighted average is used when the items to be counted are not easily distinguishable from each other. It is used when LIFO and FIFO are not applicable due to their complexity during application.

How do you calculate WAC in Excel? ›

To calculate the weighted average in Excel, you must use the SUMPRODUCT and SUM functions using the following formula: =SUMPRODUCT(X:X,X:X)/SUM(X:X) This formula works by multiplying each value by its weight and combining the values. Then, you divide the SUMPRODUCT but the sum of the weights for your weighted average.

What are the 4 inventory costs? ›

Ordering, holding, carrying, shortage and spoilage costs make up some of the main categories of inventory-related costs.

How do you calculate inventory value? ›

Inventory values can be calculated by multiplying the number of items on hand with the unit price of the items. In compliance with GAAP, inventory values are to be calculated with the lower of the market price or cost to the company.

Should I use FIFO or average cost? ›

Choosing the best cost basis method depends on your specific financial situation and needs. If you have modest holdings and don't want to keep close track of when you bought and sold shares, using the average cost method with mutual fund sales and the FIFO method for your other investments is probably fine.

What does WAC stand for in accounting? ›

Weighted Average Coupon (WAC)

What is FIFO and LIFO example? ›

Companies typically use FIFO for perishable products like food and beverages or stock that may become obsolete or expire if they don't sell within a certain time. Businesses often use LIFO for products that aren't affected by time spent in inventory or where the flow of products fits the LIFO method.

What is LIFO example? ›

Example of LIFO

that buys coffee mugs from wholesalers and sells them on the internet. One Cup's cost of goods sold (COGS) differs when it uses LIFO versus when it uses FIFO. In the first scenario, the price of wholesale mugs is rising from 2016 to 2019.

What is the FIFO rule of thumb? ›

FIFO stands for “First in – First Out.” The first part that goes in is the first part that goes out. There is no overtaking of parts. There is usually a limit to the number of parts in a FIFO lane.

Can a company use both LIFO and FIFO? ›

Financial Reporting

That being said, the IRS allows the use of both LIFO and FIFO. As a result, if you are using FIFO you will only have to value your inventory once. If you want to use LIFO for tax purposes, you will have to value your inventory twice – using LIFO for the IRS and FIFO for financial reporting.

Why would a company use LIFO instead of FIFO? ›

Reason for Using LIFO

(The higher cost of goods sold means lower net income and lower taxable income than FIFO.) Another reason for a company to use the LIFO cost flow assumption is to improve the matching of costs with sales.

Why do companies prefer LIFO? ›

Pros of LIFO

A higher cost of goods sold, lower profits, less tax liability with inflation. During deflation, lower cost of goods sold, higher profits, and higher tax liability. More profits and more appealing to investors during deflation.

Which is more common LIFO or FIFO? ›

Most companies prefer FIFO to LIFO because there is no valid reason for using recent inventory first, while leaving older inventory to become outdated. This is particularly true if you're selling perishable items or items that can quickly become obsolete.

Why is LIFO not allowed? ›

IFRS prohibits LIFO due to potential distortions it may have on a company's profitability and financial statements. For example, LIFO can understate a company's earnings for the purposes of keeping taxable income low. It can also result in inventory valuations that are outdated and obsolete.

Do restaurants use LIFO? ›

Last-in, first-out (LIFO) is another technique used to value inventory, but it's not one commonly practiced, especially in restaurants. Last-in, first-out values inventory on the assumption that the goods purchased last are sold first at their original cost.

What are the five common inventory valuation methods? ›

The five most commonly used inventory valuation methods are FIFO (First In, First Out), LIFO (Last In, First Out), FEFO (First Expired, First Out), Weighted Average, and Specific Identification.

What are the 2 methods used to determine inventory quantity? ›

Examples of Inventory Methods

The following are only a few of the many cost flow assumptions used for valuing inventory: First-in, first-out (FIFO) Last-in, first-out (LIFO)

What are the 3 components of an inventory cost? ›

Total inventory costs are frequently broken down into three distinct categories: ordering costs, carrying costs, and stockout costs. These amounts are often assessed or examined by business owners and/or management to determine how much inventory to keep on hand at any given time.

What are the 2 types of inventories? ›

Two types of inventory are periodic and perpetual inventory. Both are accounting methods that businesses use to track the number of products they have available.

What are all the types of inventory? ›

The four types of inventory most commonly used are Raw Materials, Work-In-Process (WIP), Finished Goods, and Maintenance, Repair, and Overhaul (MRO). You can practice better inventory control and smarter inventory management when you know the type of inventory you have.

What are the 6 methods of valuation? ›

Methods for determining Customs value
  • Method one – transaction value. ...
  • Method two – transaction value of identical goods (“identical goods method”) ...
  • Method three – transaction value of similar goods (“similar goods method”) ...
  • Method four – deductive value. ...
  • Method five – computed value. ...
  • Method six – residual basis of valuation.
24 Jul 2019

What are the different valuation types? ›

The main types of evaluation are process, impact, outcome and summative evaluation.

What are 7 valuing process? ›

These stages include (1) choosing freely; (2) choosing from alternatives; (3) choosing after thoughtful consideration of the consequences of each alternative; (4) prizing and cherishing; (5) affirming; (6) acting upon choices; and (7) repeating (Raths et al. 1987, pp. 199–200).

What is the difference between the FIFO and LIFO inventory method of valuing inventory quizlet? ›

Under FIFO, the ending inventory is costed at the newest unit costs, and under LIFO, the ending inventory is costed at the oldest unit costs. Therefore, when prices are rising, the ending inventory reported on the balance sheet will be higher under FIFO than under LIFO.

What is LIFO method of inventory valuation? ›

Last in, first out (LIFO) is a method used to account for inventory. Under LIFO, the costs of the most recent products purchased (or produced) are the first to be expensed. LIFO is used only in the United States and governed by the generally accepted accounting principles (GAAP).

What is the difference between FIFO LIFO and HIFO? ›

FIFO (first-in-first-out), LIFO (last-in-first-out), and HIFO (highest-in-first-out) are simply different methods used to calculate cryptocurrency gains and losses. To better understand how they work, let's calculate capital gains on the following transaction using each one of these different accounting methods.

What are the main advantages of using FIFO and LIFO? ›

Choosing Among the Methods

During periods of inflation, FIFO maximizes profits as older, cheaper inventory is used as cost of goods sold; in contrast, LIFO maximizes profits during periods of deflation. Some companies focus on minimizing taxes by picking the method with the smallest profit.

What is the basic difference between LIFO & FIFO logic give example? ›

FIFO (“First-In, First-Out”) assumes that the oldest products in a company's inventory have been sold first and goes by those production costs. The LIFO (“Last-In, First-Out”) method assumes that the most recent products in a company's inventory have been sold first and uses those costs instead.

Which method is better LIFO or FIFO? ›

FIFO is more likely to give accurate results. This is because calculating profit from stock is more straightforward, meaning your financial statements are easy to update, as well as saving both time and money. It also means that old stock does not get re-counted or left for so long it becomes unusable.

Which of the following is true about FIFO method of inventory valuation? ›

Answer and Explanation: The correct answer is d. In case of rising prices, the FIFO method will report higher inventory balance and low cost of goods sold as compared to the LIFO method.

Where is LIFO used example? ›

Example of LIFO

that buys coffee mugs from wholesalers and sells them on the internet. One Cup's cost of goods sold (COGS) differs when it uses LIFO versus when it uses FIFO. In the first scenario, the price of wholesale mugs is rising from 2016 to 2019.

How do you calculate FIFO and LIFO? ›

To calculate FIFO (First-In, First Out) determine the cost of your oldest inventory and multiply that cost by the amount of inventory sold, whereas to calculate LIFO (Last-in, First-Out) determine the cost of your most recent inventory and multiply it by the amount of inventory sold.

Why LIFO method is used? ›

Why Would You Use LIFO? The LIFO method is used in the COGS (Cost of Goods Sold) calculation when the costs of producing a product or acquiring inventory has been increasing. This may be due to inflation.

Which is better FIFO LIFO or weighted average? ›

It's the easiest calculation and the most logical approach, so unless there is a strong reason for using LIFO or weighted average, FIFO is the default. If you sell high volumes of small items, like nails and screws for example, and the costs change regularly, weighted average may make more sense.

Is LIFO and FIFO the same? ›

FIFO stands for “first in, first out” and assumes the first items entered into your inventory are the first ones you sell. LIFO, also known as “last in, first out,” assumes the most recent items entered into your inventory will be the ones to sell first.

Can you use both LIFO and FIFO? ›

Financial Reporting

That being said, the IRS allows the use of both LIFO and FIFO. As a result, if you are using FIFO you will only have to value your inventory once. If you want to use LIFO for tax purposes, you will have to value your inventory twice – using LIFO for the IRS and FIFO for financial reporting.

What are the 3 main reasons for using FIFO? ›

Less waste (a company truly following the FIFO method will always be moving out the oldest inventory first). Remaining products in inventory will be a better reflection of market value (this is because products not sold have been built more recently). Higher profit. Financial statements are harder to manipulate.

Why is LIFO more accurate? ›

Compliance with the matching principle – Unlike FIFO, LIFO complies with the matching principle, because the revenues and costs are recorded in the same period. As a result, both revenue and costs are recorded with the most recent values.

Why would a company choose FIFO over LIFO? ›

Most companies prefer FIFO to LIFO because there is no valid reason for using recent inventory first, while leaving older inventory to become outdated. This is particularly true if you're selling perishable items or items that can quickly become obsolete.

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