FIFO, LIFO, and Weighted Average: Inventory Costing Methods With Full Examples

Inventory costing is one of those topics where students understand the concept quickly but get lost in the arithmetic. FIFO, LIFO, and weighted average cost are three different methods for assigning costs to inventory sold and inventory remaining on hand — and they can produce dramatically different financial statement results. This article explains every method from first principles, with complete numerical examples using the same data set so you can see exactly how the results differ.

Why the Costing Method Matters

In a world of constant prices, inventory costing would be trivial — every unit would cost the same regardless of when it was purchased. In the real world, prices fluctuate, and a company that buys inventory at different prices must decide which cost to assign to units sold (cost of goods sold) and which cost to assign to units remaining (ending inventory).

This decision has significant financial statement implications. The costing method affects gross profit, net income, income taxes, and the value of inventory on the balance sheet. Choosing a different method does not change the physical flow of goods — it changes only the accounting assignment of costs. Importantly, the method must be applied consistently from period to period, and any change requires disclosure and retrospective application.

FIFO: First-In, First-Out

FIFO assumes that the first units purchased are the first units sold. Ending inventory consists of the most recently purchased units. In periods of rising prices, FIFO produces lower COGS (older, cheaper costs are expensed) and higher ending inventory (newer, more expensive costs remain on the balance sheet).

We will use this data set for all three methods:

Purchase and Sales Data — Northgate Electronics

Date	Transaction	Units	Unit Cost	Total Cost
1 Jan	Beginning inventory	100	$10	$1,000
5 Jan	Purchase	200	$12	$2,400
15 Jan	Purchase	150	$14	$2,100
20 Jan	Sale (280 units)	280	—	—
Goods available for sale (450 units)		450		$5,500

FIFO COGS calculation: The first 100 units sold come from beginning inventory at $10 each = $1,000. The next 180 units come from the 5 Jan purchase at $12 each = $2,160. Total COGS = $1,000 + $2,160 = $3,160.

FIFO ending inventory: 450 − 280 = 170 units remaining. These are the 20 units remaining from the 5 Jan lot (200 − 180 = 20) at $12, plus 150 units from the 15 Jan purchase at $14. Ending inventory = (20 × $12) + (150 × $14) = $240 + $2,100 = $2,340.

Verification: COGS $3,160 + Ending inventory $2,340 = $5,500 ✓ (equals goods available for sale).

LIFO: Last-In, First-Out

LIFO assumes that the most recently purchased units are sold first. Ending inventory consists of the oldest units. In periods of rising prices, LIFO produces higher COGS (newer, more expensive costs are expensed) and lower ending inventory (older, cheaper costs remain on the balance sheet). This means lower net income and lower taxes — which is why many US companies prefer it. LIFO is prohibited under IFRS.

LIFO COGS calculation (same 280 units sold): The first 150 units come from the 15 Jan purchase at $14 each = $2,100. The next 130 units come from the 5 Jan purchase at $12 each = $1,560. Total COGS = $2,100 + $1,560 = $3,660.

LIFO ending inventory: 170 units remaining. These consist of 100 units from beginning inventory at $10, plus 70 units from the 5 Jan purchase at $12. Ending inventory = (100 × $10) + (70 × $12) = $1,000 + $840 = $1,840.

Verification: COGS $3,660 + Ending inventory $1,840 = $5,500 ✓

Weighted Average Cost

The weighted average method calculates a single average cost per unit using all units available for sale, then applies that average to both COGS and ending inventory. It smooths out price fluctuations and falls between FIFO and LIFO in most outcomes.

Weighted Average Cost Per Unit

Total cost of goods available for sale ÷ Total units available
= $5,500 ÷ 450 units
= $12.22 per unit (rounded)

Weighted average COGS: 280 units × $12.22 = $3,422

Weighted average ending inventory: 170 units × $12.22 = $2,078

Verification: $3,422 + $2,078 = $5,500 ✓

Note: The perpetual weighted average method recalculates the average cost after each purchase, producing a slightly different result than the periodic weighted average. Most introductory courses use the periodic method shown here.

Side-by-Side Comparison

Results Comparison — Rising Prices Scenario

Metric	FIFO	Weighted Avg	LIFO
Cost of goods sold	$3,160	$3,422	$3,660
Ending inventory	$2,340	$2,078	$1,840
Gross profit (assuming revenue $6,000)	$2,840	$2,578	$2,340
Income tax (at 30%)	$852	$773	$702

In a rising price environment: FIFO = highest gross profit, highest inventory balance, highest taxes. LIFO = lowest gross profit, lowest inventory balance, lowest taxes. Weighted average = in the middle. In a falling price environment, all relationships reverse.

The LIFO Reserve

Companies that use LIFO must disclose the LIFO reserve — the difference between what ending inventory would be under FIFO and what it actually is under LIFO. The LIFO reserve grows during periods of rising prices as the difference between the layers accumulates.

Analysts use the LIFO reserve to convert a LIFO company's financials to a FIFO basis for comparison to FIFO competitors: FIFO inventory = LIFO inventory + LIFO reserve. This comparison adjustment is commonly tested in financial analysis and CPA exam questions.

A LIFO liquidation occurs when a company sells more inventory than it purchases, drawing down old LIFO layers with very low costs. This temporarily inflates gross profit and creates a one-time taxable gain — a red flag for analysts reviewing LIFO companies' results.

Key Exam Points

FIFO and LIFO names describe what is sold first, not what arrives first physically
Goods available for sale = Beginning inventory + Purchases (this must be your constant check)
COGS + Ending inventory = Goods available for sale (always verify this — if it does not balance, there is an error)
LIFO is prohibited under IFRS but permitted under US GAAP
In rising prices: FIFO → higher income, higher taxes, higher balance sheet inventory
The LIFO reserve bridges LIFO and FIFO balance sheet values

📌 Memory Trick

FIFO = oldest costs expensed, newest costs on balance sheet. LIFO = newest costs expensed, oldest costs on balance sheet. In rising prices, LIFO gives you the most current COGS (good for tax minimisation) and FIFO gives you the most current balance sheet (good for looking healthy to lenders).

Practice Inventory Costing Questions

PrepQBank generates fresh FIFO, LIFO, and weighted average problems at every difficulty level — from simple one-purchase scenarios to complex LIFO liquidation and reserve analysis questions.

Practice inventory costing →