3 Inventory Valuation Methods: FIFO, LIFO and AVCO

Written by Zachary Kremian, Supply Times

In order to remain competitive, companies across industries have increased their emphasis on inventory valuation. In easy-speak, companies can no longer afford lax oversight over inventory assets – raw materials, parts, components, produced goods, etc. – and  have shifted a bulk of time, resources and revenues to developing precise inventory accounting systems.

3 inventory valuation methods, Fishbowl Inventory BlogAlthough many companies have turned to perpetual inventory systems for real-time visibility of current inventory values, periodic inventory systems are still a mainstay for many companies in manufacturing, logistics and fulfillment – or at least remain a component of the inventory valuation process.

For businesses using a periodic inventory accounting system, only revenues are updated after a sale – and not actual inventory value. In periodic systems, on the other hand, a regularly scheduled physical inventory check is required to gain total visibility of inventory assets and value.

Therefore, if a periodic system is in place, it’s critical for manufacturers to grasp the three major costing methods, when they should be applied, and how they may affect cost flow:

First in first out (FIFO)

Defined: The oldest inventory asset is recorded as sold first – regardless of the actual shelf age of the given physical asset.

Applied: While it is the most widely used accounting technique in periodic inventory management today, FIFO may fail to offer a full picture of inventory value if inflation and price increases are not closely analyzed. Thus, FIFO may inflate or deflate the actual value of future inventory.

Last in first out (LIFO)

Defined: The newest inventory asset is recorded as sold first.

Applied:  The LIFO method could reduce a company’s tax responsibility in times of growing inflation – but it has been heavily regulated under the International Financial Reporting Standards.

Average cost or weighted cost (AVCO)

Defined: The AVCO (average cost) method will take the total cost of goods still available for sale and divide it by the total sum of product from the beginning inventory and purchases.

Applied: With the AVCO method, cost flow is determined as a weighted average of all total unit costs.

Looking for more insights into inventory valuation?  For the latest whitepapers, guides and industry news, check out Supply Times.


About Robert Lockard

Robert Lockard is a copywriter with Fishbowl. He writes for several blogs about inventory management, manufacturing, QuickBooks and small business. Fishbowl is the #1-requested manufacturing and warehouse management software for QuickBooks users. Robert enjoys running, reading, writing, spending time with his wife and children, and watching movies.
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5 Responses to 3 Inventory Valuation Methods: FIFO, LIFO and AVCO

  1. wms says:

    Inventory management is an amazing concept, but it has to be done properly. Some recommendations for effective rendering of inventory control are to have the best application available for your company.

  2. Abel Sondo says:

    It would have been much easier if there was an example of all the three stock valuation methods

  3. Pingback: Which Inventory Valuation Method Works Best for You? | Fishbowl Inventory Blog

  4. Samiullah says:

    Which method is best for manufacturing industry and which for oil industry?

    • First off, the most important thing is to be consistent, no matter which one a company chooses. When you pick one, stick with it to avoid confusion down the line.

      To answer your question, I think FIFO makes the most sense because then the cost of each product or gallon of oil that gets sold matches up with what it cost to produce it and/or obtain it in the first place.

      A manufacturer will continue to work through its inventory and sell off newer and older products, but the nice thing is that the accounting books will balance nicely as the costs out match the costs in.

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