FIFO, LIFO, and Average Inventory System: Difference and Similarities

The cost of ending inventory and the cost of goods sold is determined using various methods of them, the commonly used methods are:

1. First-in first-out (FIFO),
2. Last in first-out (LIFO), and
3. Weighted average.

All expenditures needed to acquire goods and to make them ready for sale are included as the inventorial cost. It appears from the diagram that; the

But in practice, goods are purchased several times at different prices for a particular period, and the same is the case with sales.

In such a situation, the determination of the cost of ending inventory becomes very difficult. These methods are described below with an example.

First, let’s look at the information given in the following table;

Now see the definitions and see what the cost of ending inventory in each method is;

LIFO Method

Under this method, to price the issues, it is assumed that the last receipts are issued first. The major objectives of the LIFO method are to change the cost of goods sold with the most recent cost incurred.

FIFO Method

The FIFO method assumes that the earliest goods purchased are the first to be sold, FIFO often parallels the actual physical.flow of merchandise, it generally is a good business practice as to sell the oldest unit first.

Inventory method that assumes that the costs of the earliest goods purchased are the first to be recognized as cost of goods sold.

Average Method

Inventory costing method uses the weighted average unit cost to allocate to ending inventory and cost of goods sold the cost of goods available for sale.

The average cost method will take the total cost of goods that will available for sale and divide it by the total sum of the product from the inventory and purchases.

What are the relationships of FIFO, LIFO, and Average Inventory System?

The following points show the relationship between LIFO, FIFO and average inventory system:-

1. Inventory Cost Determination: Since they are different, but the objectives of this method are the same.
2. Income Effect: The cost of this method can vary, but the effect of income in financial statements is the same.
3. Revenue Matching: The cost of each method be varied, but this be matched with the revenue section.
4. Inventory Level Determination: Each method indicates how many units should be produced and how much saved.

Among FIFO, LIFO, and Average Inventory System, the LIFO is the best measure because;

1. The major objectives Of the LIFO method to change the cost of goods sold with the most recent cost incurred.
2. Adjust the financial statements for inflation.
3. To obtain a better matching of current revenues with current costs in times of inflation.

Difference between FIFO, LIFO, and Average Inventory System?