Inventory cost formulas: FIFO and weighted average

When identical goods are bought at different prices, the business can't usually say which physical unit it sold. A cost formula decides which costs go to cost of sales and which stay in closing inventory. Whatever formula is used, the total is fixed: opening inventory + purchases = cost of sales + closing inventory. The formula only decides the split — and therefore profit.

What IAS 2 allows. - Specific identification (IAS 2.23) for items that are not ordinarily interchangeable, or are produced for specific projects: custom-built machinery, individually registered vehicles, works of art. The actual cost of each item follows it. - For everything else, FIFO or weighted average (IAS 2.25). The same formula is used for all inventories of a similar nature and use. - LIFO is prohibited under IFRS. US GAAP (ASC 330) still permits LIFO, so a US company's inventory may need restating when it reports under IFRS.

The formulas. - FIFO (first in, first out) assumes the oldest units are sold first; closing inventory is the most recent purchases. FIFO gives the same answer under periodic and perpetual records. - Periodic weighted average computes one average for the whole period: cost of goods available ÷ units available. - Moving average (perpetual) recalculates the average after every purchase, and each sale is costed at the average on that day — so later purchases don't affect earlier sales.

Why it matters. When prices are rising, FIFO charges the oldest, cheapest costs to cost of sales, so it reports the highest profit and an inventory figure close to current cost. When prices are falling, the effect reverses: FIFO charges the older, dearer costs and reports lower profit than an average. Averages smooth price changes in both directions.