FIFO vs weighted average cost: which inventory method fits?
When you buy the same product at different prices, you need a rule for which cost goes to the units you sell. The rule you pick changes your cost of goods sold, your profit and the value of the stock left on your shelves.
One example, three methods
A business buys the same product three times as prices rise, then sells 180 units at $22 each.
| Purchase | Units | Cost per unit | Total |
|---|---|---|---|
| Opening stock | 100 | $10 | $1,000 |
| February order | 100 | $12 | $1,200 |
| March order | 100 | $14 | $1,400 |
| Total available | 300 | $3,600 |
FIFO: first in, first out
FIFO assumes the oldest units sell first. The 180 units sold are the 100 opening units and 80 from February.
COGS = (100 × $10) + (80 × $12) = $1,960 · Ending stock = (20 × $12) + (100 × $14) = $1,640
FIFO usually matches how stock physically moves, especially for anything with a shelf life. When prices are rising it gives lower COGS and higher profit, and the stock on your balance sheet is valued close to current prices.
Weighted average cost
Weighted average spreads cost evenly: $3,600 ÷ 300 units = $12.00 per unit.
COGS = 180 × $12.00 = $2,160 · Ending stock = 120 × $12.00 = $1,440
Average cost smooths out price swings and suits interchangeable goods, such as bulk materials or identical parts stored together. With perpetual tracking, the average is recalculated after each purchase, which is sometimes called moving average.
What about LIFO?
LIFO, last in, first out, assumes the newest units sell first. In this example COGS would be (100 × $14) + (80 × $12) = $2,360, and ending stock would be $1,240.
LIFO is allowed under US GAAP and for US taxes but not under IFRS. If a business uses LIFO on its US tax return, the IRS conformity rule generally requires it in financial statements given to owners and lenders too. It is far less common among small businesses because of the extra record keeping.
Side by side
| Method | COGS | Gross profit on $3,960 of sales | Ending stock |
|---|---|---|---|
| FIFO | $1,960 | $2,000 | $1,640 |
| Weighted average | $2,160 | $1,800 | $1,440 |
| LIFO | $2,360 | $1,600 | $1,240 |
The total cost is the same $3,600 in every case. The methods only change how much is counted as sold this period versus still on the shelf. When prices fall, the order reverses and FIFO gives the highest COGS.
How to choose
- FIFO fits most product sellers, and anything perishable or seasonal.
- Weighted average fits identical items mixed together, where tracking each batch is impractical.
- Specific identification, tracking the actual cost of each unit, fits high-value items with serial numbers, such as equipment or vehicles.
Whatever you choose, use it consistently. Changing methods for US tax purposes generally requires IRS approval, usually by filing Form 3115, so decide with your accountant before your first tax year.
Common questions
Can I use different methods for different products?
In general, yes, if each is applied consistently and your accountant agrees. For example, specific identification for serialized equipment and FIFO for parts.
Which method lowers my taxes?
When prices rise, methods that give a higher COGS, like LIFO, lower taxable income. But tax rules are specific, so talk to a tax professional before choosing a method for tax reasons.
Keep your books this way without the busywork
YourAILedger tracks inventory, purchase orders and suppliers, reconciles imported bank statements and guides your month-end close. Plans start at $29 a month.
No credit card required.
This guide is general education, not tax, legal or accounting advice. Rules vary by business and location, so confirm your situation with a qualified professional.