FIFO, LIFO or average cost: how each one values your stock

Two businesses buy exactly the same goods at exactly the same prices, sell the same quantities, and end the year with the same units on the shelf. One reports a higher stock value and a higher profit than the other. Neither has made a mistake. They value stock with different costing methods.

When prices change over time, the units you hold were not all bought at the same price. A costing method is the rule that decides which price each unit sold, and each unit left, carries.

One example, three answers

You buy a product twice:

Then you sell 120 units. You paid €2,200 in total, and 80 units are left. The question is how to split that €2,200 between what you sold and what you still hold.

FIFO (first in, first out) assumes the oldest units leave first. The 120 sold are the 100 from January at €10 and 20 from March at €12, a cost of €1,240. The 80 left are valued at the March price: €960.

LIFO (last in, first out) assumes the newest units leave first. The 120 sold are the 100 from March at €12 and 20 from January at €10, a cost of €1,400. The 80 left are valued at the January price: €800.

Average cost values every unit at the weighted average of what you paid: €2,200 for 200 units, €11 each. The 120 sold cost €1,320 and the 80 left are worth €880.

Every row adds up to the same €2,200. The method does not change what you spent. It changes when that spending shows up as cost, and how much of it is still sitting on the balance sheet as stock.

What each method tells you

FIFO keeps the stock value close to what you would pay to buy it again today, because what remains is your most recent purchases. When prices rise, it reports a lower cost of sales and a higher profit. It also tends to match how goods physically move: the oldest stock usually goes out first.

LIFO charges your most recent prices to the goods you sold, so when prices rise it reports a higher cost of sales and a lower profit. The stock left on the balance sheet is valued at older prices, which can drift far from what it would cost to replace.

Average cost smooths things out. A single expensive or cheap batch is spread across the whole holding instead of showing up all at once, which makes margins steadier from month to month.

When prices fall, FIFO and LIFO swap places: FIFO reports the higher cost of sales.

Which one can you use

That depends on the accounting rules you report under, so the choice belongs with your accountant. A few points are worth knowing before that conversation:

• International Financial Reporting Standards (IAS 2) allow FIFO and weighted average cost, and do not permit LIFO.
• US GAAP permits LIFO as well.
• In Italy, the civil code (article 2426) allows weighted average, FIFO and LIFO for interchangeable goods.
• Whatever you choose, apply it consistently. Switching methods from one year to the next makes your figures hard to compare and usually has to be justified and disclosed.

How StockBold values your stock

In StockBold you choose FIFO, LIFO or average cost once, for the whole organisation, in the settings. Only the owner can change it. Each delivery enters stock at what it cost: the purchase price converted into your currency, plus its share of freight, duty and other landed costs. When stock leaves, your method decides which of those costs leave with it.

The inventory valuation report rebuilds the value from your movement history for any date you pick, and shows which method it used. Because it is rebuilt from history, changing the method changes the value on past dates too. That is why StockBold refuses a change while any year is locked: a closed year’s figures stay as they were reported.

The COGS report uses the same method: each sale is costed at what your method takes out of stock, so cost of goods sold and the stock value add up.

Read more about stock valuation in StockBold, or the help guide on the inventory valuation report.