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Financial Accounting · Inventories

Inventory Costing Methods: FIFO, AVCO and LIFO

Updated 11 October 2026 · Fact-checked

Inventory costing methods decide which purchase costs are charged to cost of sales and which stay in closing inventory. FIFO assumes the oldest items are issued first. AVCO uses a weighted average cost per unit. IAS 2 does not permit LIFO. Pick the method, price each issue, then value what is left.

Understand Inventory Costing Methods: FIFO, AVCO and LIFO

When a business buys the same item at different prices, it must decide which cost goes to cost of sales when units are sold, and which cost stays in closing inventory. You cannot always tell which physical unit was sold, so IAS 2 Inventories allows cost formulas to answer this.

FIFO (first in, first out) assumes the oldest units are sold first. Closing inventory is therefore made up of the most recent purchases. When prices are rising, FIFO gives a lower cost of sales, a higher profit and a higher closing inventory value.

AVCO (weighted average cost) gives every unit in stock the same average cost. The average is the total cost of units available divided by the number of units available. It can be recalculated after each purchase (continuous) or once at the end of the period (periodic). Unless the question says otherwise, use the method it states.

LIFO (last in, first out) assumes the newest units are sold first. IAS 2 does not permit it. Under LIFO, closing inventory would be valued at old costs, which can be far from current prices. That misstates the asset on the statement of financial position. It is also easy to use to manage profit.

IAS 2 also says a business should use the same cost formula for all inventories with a similar nature and use. The cost formula only decides what cost is attached to the units. Inventory is still valued at the lower of cost and net realisable value.

Key formulas to remember

FIFO
Issues are costed at the oldest unit costs first; closing inventory is costed at the latest purchase prices
Work through the purchase layers in date order, using up the oldest layer before the next.
AVCO (continuous)
Average cost per unit = (Cost of units in stock + Cost of new purchase) ÷ (Units in stock + Units purchased)
Recalculate after every purchase. Issues do not change the average, they only reduce units and total value.
AVCO (periodic)
Average cost per unit = Total cost of opening inventory and purchases ÷ Total units of opening inventory and purchases
Use only when the question asks for one average for the period.
Closing inventory check
Opening inventory + Purchases − Cost of goods sold = Closing inventory
Use this to check your answer. Whatever method you use, the total must reconcile.
Lower of cost and NRV
Inventory value = lower of cost and net realisable value (NRV)
NRV = estimated selling price − estimated costs to complete − costs necessary to make the sale. Apply it item by item.
LIFO
Not permitted under IAS 2
Do not use it for a financial reporting answer.

How to solve Inventory Costing Methods: FIFO, AVCO and LIFO questions

Use this layout for any question on inventory costing. Stay organised and the arithmetic is easy.

  1. 1Read which method the question requires: FIFO or AVCO. If the question says LIFO, remember it is not allowed under IAS 2.
  2. 2List every movement in date order: opening inventory, purchases and sales, with units and unit costs.
  3. 3Check the units. Opening units plus purchases minus issues must give the closing units.
  4. 4For FIFO, take each issue from the oldest layer first. Note what is left in each layer.
  5. 5For AVCO, calculate the average cost after each purchase, or once for the period if asked. Price each issue at the current average.
  6. 6Calculate closing inventory as closing units × cost per unit (AVCO) or as the sum of the remaining layers (FIFO).
  7. 7Calculate cost of sales and check it: opening inventory + purchases − closing inventory.
  8. 8If NRV is given, compare cost and NRV for each item and use the lower.

Quickest way: Layer list and total-value check

When to use it: Use this for multiple-choice and number-entry questions where you only need closing inventory or cost of sales and have little time.

  1. For closing inventory under FIFO, ignore the issues' costs. Take the closing units from the most recent purchases backwards.
  2. For closing inventory under AVCO periodic, divide total cost by total units, then multiply by closing units.
  3. For continuous AVCO, keep a running total of units and value. Only recalculate the average after a purchase.
  4. Check the answer with: total cost available − closing inventory = cost of sales.
  5. Compare the options. If prices are rising, FIFO closing inventory should be higher than AVCO, so reject any option that contradicts this.

Common mistakes in Inventory Costing Methods: FIFO, AVCO and LIFO

  • Taking the closing inventory under FIFO from the oldest purchases instead of the latest.

    Students confuse which units are sold first with which units remain.

    Fix: Under FIFO the oldest units are sold, so what is left is the newest. Build closing inventory from the last purchase backwards.

  • Using a simple average of unit prices, for example (₹10 + ₹12) ÷ 2.

    It looks quicker and the figures seem to fit.

    Fix: Weight the average by quantity. Divide total cost by total units.

  • Not recalculating AVCO after a purchase made after a sale.

    Students use one average for the whole period when continuous AVCO is requested.

    Fix: After each purchase, add the new cost and units to the stock balance and divide again. Sales do not change the average.

  • Using LIFO because the question mentions it or because it seems an easy option.

    LIFO is covered in some other systems and in some textbooks.

    Fix: IAS 2 does not permit LIFO. Only FIFO and weighted average cost are acceptable formulas for financial reporting.

  • Ignoring net realisable value.

    The costing method is the focus, so the lower of cost and NRV test is forgotten.

    Fix: After costing, check each item's NRV if the question gives selling price and selling costs. Write down the lower figure.

  • Making the units not agree with the closing count.

    A sale or return is left out or a purchase is double counted.

    Fix: Reconcile units first. Opening units + purchases − sales must equal closing units.

Worked examples

Example 1

A business had no opening inventory. It bought 100 units at $10 on 1 May and 100 units at $12 on 10 May. It sold 150 units on 20 May. Calculate the closing inventory value and cost of sales using FIFO.

Show the solution
  1. Units: 100 + 100 − 150 = 50 units in closing inventory.
  2. Under FIFO the 150 units sold come from the oldest layers: all 100 units at $10 and 50 units at $12.
  3. Cost of sales = 100 × $10 + 50 × $12 = $1,000 + $600 = $1,600.
  4. The remaining 50 units come from the 10 May purchase: 50 × $12 = $600.
  5. Check: total purchases = $1,000 + $1,200 = $2,200. Cost of sales $1,600 + closing inventory $600 = $2,200.

Answer: FIFO cost of sales is $1,600 and closing inventory is $600.

Example 2

Using the same data as the first example, but the 150 units were sold on 5 May after only the first purchase, then the second purchase was made on 10 May. No opening inventory. Sales on 5 May: 60 units. Sales on 20 May: 90 units. Calculate closing inventory using continuous AVCO.

Show the solution
  1. 1 May: buy 100 units at $10 = $1,000. Average cost = $10.
  2. 5 May: sell 60 units at $10 = $600. Stock is now 40 units worth $400.
  3. 10 May: buy 100 units at $12 = $1,200. Stock is now 140 units worth $400 + $1,200 = $1,600.
  4. New average = $1,600 ÷ 140 = $11.4286 per unit (to four decimal places).
  5. 20 May: sell 90 units at $11.4286 = $1,028.57. Stock is now 50 units.
  6. Closing inventory = $1,600 − $1,028.57 = $571.43, which equals 50 × $11.4286.
  7. Cost of sales = $600 + $1,028.57 = $1,628.57. Check: $2,200 − $571.43 = $1,628.57.

Answer: Closing inventory is $571.43 (rounded) and cost of sales is $1,628.57.

Exam tips

  • Read the method in the question. Questions on this topic often test FIFO and AVCO side by side, so do not mix them.
  • In multiple-choice questions, do the arithmetic once, then use the check: total cost available − closing inventory = cost of sales.
  • Under AVCO, keep at least four decimal places during working and round only the final answer.
  • If a multiple-response question asks which statements are true, remember: LIFO is not permitted by IAS 2, and in times of rising prices FIFO gives a higher profit than AVCO.
  • If a question gives NRV, always compare it with cost before you finalise the inventory figure.

Practice questions from Inventories

Inventory Costing Methods: FIFO, AVCO and LIFO in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Inventory Costing Methods: FIFO, AVCO and LIFO: frequently asked questions

What is the difference between FIFO and AVCO?

FIFO assumes the oldest units are sold first, so closing inventory is valued at the most recent costs. AVCO gives every unit the same weighted average cost. When prices rise, FIFO gives a higher closing inventory and a higher profit than AVCO.

How do I calculate closing inventory using weighted average cost?

Divide the total cost of the units available by the number of units available to get the average cost per unit. Multiply that by the closing units. If the question wants continuous AVCO, recalculate the average after each purchase.

Why is LIFO not allowed under IAS 2?

IAS 2 permits only specific identification for special items, FIFO and weighted average cost. LIFO can leave inventory valued at very old costs, which does not reflect current prices on the statement of financial position. It can also be used to manage profit.

Do FIFO and AVCO change the total cost over time?

No. Over the whole life of the business the total cost charged to profit is the same. The methods only change how that cost is split between cost of sales and closing inventory in each period.