FIFO vs Weighted Average Cost
FIFO vs Weighted Average Cost is the choice between two allowed ways of valuing inventory: FIFO assumes the oldest stock is sold first, while Weighted Average pools all units at a blended cost. The choice sits in the inventory valuation policy behind the balance sheet. It matters because, when prices move, the two methods give different closing stock, cost of goods sold and reported profit from the same purchases.
What Is FIFO vs Weighted Average Cost?
Both FIFO and Weighted Average are cost formulas for assigning a value to inventory when identical items were bought at different prices. FIFO — first in, first out — charges the earliest costs to cost of goods sold, leaving the most recent costs in closing stock. Weighted Average recalculates a single average cost across all units held, so each issue carries that blended rate. Neither tracks the physical goods; both are accounting assumptions about cost flow.
An Indian business meets this choice when it sets its inventory policy under AS 2 or Ind AS 2, both of which permit FIFO and Weighted Average but prohibit LIFO. In a period of rising material prices, FIFO reports a higher closing stock and profit, while Weighted Average smooths the effect. The chosen method must be applied consistently, because switching it changes profit and invites both audit and tax scrutiny.
Key terms
- Standard Cost Variance — An alternative costing basis compared against actual cost.
- Inter-Company Ledger Reconciliation — Reconciling stock transferred between group companies.
- Vendor Balance Confirmation — Confirming supplier balances that underlie purchase costs.
Why FIFO vs Weighted Average Cost Matters
The method chosen changes the numbers, not just the paperwork:
- Different reported profit — With prices rising, FIFO shows higher profit than Weighted Average from the same purchases, changing tax payable.
- Different closing stock value — The balance-sheet inventory figure shifts with the method, affecting current assets and ratios lenders watch.
- Consistency requirement — AS 2 requires consistent application; an unjustified switch is an accounting-policy change needing disclosure and scrutiny.
- Tax exposure on method change — Changing method to lower profit can be challenged by the assessing officer as a device to defer tax.
- Comparability with peers — Two firms on different methods are not directly comparable, so analysts must adjust before benchmarking.
How FIFO vs Weighted Average Cost Works - Step by Step
Each method assigns cost to issues and closing stock differently:
- 1Record purchases at cost
Every receipt is logged with its quantity and rate — the stock ledger that both methods read from.
- 2Choose the cost formula
The inventory policy fixes FIFO or Weighted Average, applied consistently across the period.
- 3Value each issue
FIFO charges the oldest rate to each sale; Weighted Average charges the running average rate.
- 4Recompute the average (WAC only)
Under Weighted Average, a fresh average is struck after each purchase, updating the issue rate.
- 5Value closing stock
Remaining units are valued at recent cost (FIFO) or the final average (WAC), flowing to the balance sheet.
How to Calculate FIFO vs Weighted Average Cost
Weighted average cost per unit = Total cost of units available ÷ Total units available| Input | Where it comes from | Sample value (INR) |
|---|---|---|
| Opening + purchases (cost) | Stock ledger | 2,20,000 |
| Opening + purchases (units) | Stock ledger | 1,000 units |
| Units issued / sold | Sales / production records | 600 units |
Weighted average = 2,20,000 ÷ 1,000 = ₹220 per unit, so 600 units issued cost ₹1,32,000 and 400 units close at ₹88,000. Under FIFO, the same issues would be priced at the earliest purchase rates instead.
FIFO vs Weighted Average Cost: A Practical Example
| Particulars | Amount (INR) | Treatment |
|---|---|---|
| Opening 400 units @ ₹200 | 80,000 | In stock ledger |
| Purchase 600 units @ ₹233.33 | 1,40,000 | In stock ledger |
| Issue 600 units - FIFO (400@200 + 200@233.33) | 1,26,667 | COGS under FIFO |
| Issue 600 units - Weighted Average (@₹220) | 1,32,000 | COGS under WAC |
| Closing stock difference (FIFO vs WAC) | 5,333 | Higher profit under FIFO |
A Delhi electronics trader holds 400 units at ₹200 and buys 600 more at ₹233.33. Selling 600 units, FIFO charges ₹1,26,667 to cost of goods sold while Weighted Average charges ₹1,32,000. FIFO leaves a higher closing stock and about ₹5,333 more profit for the period — the same goods, a different number, driven only by the cost formula chosen.
Switching method to flatter profit: Changing from Weighted Average to FIFO to lift profit without cause is a policy change that draws tax and audit challenge → keep the method consistent and disclose any genuine change.
Common Mistakes With FIFO vs Weighted Average Cost
Inventory costing errors usually trace back to method discipline:
- Switching method to flatter profit — Changing from Weighted Average to FIFO to lift profit without cause is a policy change that draws tax and audit challenge → keep the method consistent and disclose any genuine change.
- Using LIFO — Applying last-in-first-out is not permitted under AS 2 or Ind AS 2 → use FIFO or Weighted Average only.
- Not updating the average — Failing to recompute the weighted average after each purchase issues stock at a stale rate → recalculate on every receipt.
- Mixing methods across items — Costing similar inventory on different formulas breaks comparability → apply one formula to items of similar nature and use.
FIFO vs Weighted Average Cost is the choice between two allowed ways of valuing inventory: FIFO assumes the oldest stock is sold first, while Weighted Average pools all units at a blended cost. The choice sits in the inventory valuation policy behind the balance sheet. It matters because, when prices move, the two methods give different closing stock, cost of goods sold and reported profit from the same purchases.
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Applicable framework: AS 2 / Ind AS 2 (inventory valuation; FIFO and Weighted Average permitted, LIFO prohibited). For general information only, not professional advice. Verify the current position for your entity before acting.