Settings Inventory Cost Recognition Methods

FIFO

FIFO stands for first-in, first-out, meaning the oldest inventory items are recorded as sold first, but this do not mean that the exact oldest physical object has been tracked and sold. With FIFO, the cost of inventory reported on the balance sheet represents the cost of the inventory most recently purchased.

Example: ABC Co. in September had the following current inventory, in order of purchase:

ABC Co. in September sells 210 units and would expense the first 100 units at $50 and the remaining 110 units at $55. Under FIFO, the total cost of sales would have been $11,050. The ending inventory would be calculated as follows:

Thus, the balance sheet would now show the inventory valued at $5,250.

LIFO

LIFO stands for last-in, first-out, meaning that the most recently produced or stored items, are recorded as sold first.

Example: ABC Co. in September had the following inventory, in order of purchase:

ABC Co. in September sells 210 units and would expense the cost associated with the first 75 units, at $59, 125 more units at $55, and the remaining 10 units at $50. Under LIFO, the total cost of sales would have been $11,800. The ending inventory would be calculated as follows:

The balance sheet would now show the inventory valued at $4,500.

The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the LIFO reserve. In the example above, it is $750. This reserve is the amount by which an entity's taxable income has been deferred by using the LIFO method.

WAC

WAC stands for Weighted Average Cost. Using WAC, you value your inventory using the average cost of goods sold, of all inventory, to determine the inventory value of one item. The costs of all inventory in one period, are averaged to determine the cost of each piece.

 Example: ABC Co. in September had the following inventory, in order of purchase:

Total   300        54.33           16,300

ABC Co. in September sells 210 units and would expense the cost associated at $54.33 each.

Under WAC, the total cost of sales would have been $11,409.30.

The ending inventory would be calculated as follows: 

The balance sheet would now show the inventory valued at $4,890.