The World of Inventory Costing

In the business world, one can expect to be faced with many tasks that they may or may not know about

. I'm sure most of you have found yourself in this position before. This especially holds true for many things in the accounting field such as calculating depreciation and figuring out your expenses. One other extremely important factor is calculating inventory. There are three basic approaches to calculating inventory that are allowed by GAAP; FIFO or first in, first out; LIFO or last in, first out; and Weighted Average. FIFO, LIFO, and Weighted Average. These are accounting techniques used in managing inventory and financial matters involving the money a company has tied up within its inventory of produced goods and raw materials.

FIFO stands for first in, first out. This means that the oldest items in the inventory are recorded as sold first. This is based upon the cost of goods or materials bought earliest in the period. Using this inventory costing method, the results are valued closest to current replacement costs. When using FIFO during periods of inflation, it will produce the lowest estimate of cost of goods sold compared to the other two methods and the highest net income.

LIFO stands for last in, last out. This means the the newest items in the inventory are recorded as sold first. This is based upon the cost of goods or materials bought latest in the period. When using LIFO it will produce cost that approximate current costs. During periods of inflation, LIFO will produce the highest estimate of cost of goods sold and the lowest net income.

The method of Weighted Average is when both inventory and the cost of goods sold are based upon the average cost of all the units bought during that period. In a business that sells it inventory quickly, this will more likely resemble FIFO. Weighted Average is determined by dividing total cost of goods available for sale by total units available for sale.

No company is the same, which is why it is important to understand the advantages and disadvantages of each inventory costing method. Hopefully this article has helped you get a foot hold on the three most commonly used methods of accounting for inventory.

Author: Benjamin Bell

The World of Inventory Costing

By: Benjamin Bell

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