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Management Accounting · Accounting for material, labour and overheads

FIFO, LIFO and AVCO Inventory Valuation Explained

Updated 11 October 2026 · Fact-checked

FIFO, LIFO and AVCO are ways to put a cost on materials issued to production and on closing inventory. FIFO issues the oldest cost first. LIFO issues the newest cost first. AVCO uses a weighted average cost. Track units and cost in a stores record, then price each issue.

Understand Accounting for Materials: Inventory Valuation (FIFO, LIFO, AVCO)

A business buys materials at different prices over time. When it issues materials to production, it must decide which price to charge. That choice sets the cost of materials used. It also sets the value of what is left in inventory.

There are three methods you must know. FIFO (first in, first out) assumes the oldest units are issued first. Issues are charged at older prices and closing inventory is valued at the most recent prices. LIFO (last in, first out) assumes the newest units are issued first. Issues are charged at recent prices and closing inventory is valued at the oldest prices. AVCO (weighted average cost) charges every issue at an average price.

These are assumptions about cost flow. They do not have to match how the goods physically move. The total cost of opening inventory plus purchases is fixed. The method only decides how that total is split between cost of issues and closing inventory.

The effect on profit depends on price movements. When prices are rising, FIFO gives the lowest cost of issues, the highest closing inventory and the highest profit. LIFO gives the highest cost of issues, the lowest closing inventory and the lowest profit. AVCO falls between the two. When prices are falling, the order reverses. If prices are steady, all three methods give the same answer.

LIFO is useful for learning cost flow, but IAS 2 does not permit it for financial reporting under IFRS. Management accounts can use any method the business chooses, so it still appears in management accounting questions.

Key formulas to remember

Total cost identity
Opening inventory + Purchases = Cost of issues + Closing inventory
Use this to check your answer. If it does not balance, you made an error.
FIFO issue rule
Issue from the oldest batch first, then the next oldest
Closing inventory is made up of the newest batches.
LIFO issue rule
Issue from the newest batch on hand first, then the next newest
Closing inventory is made up of the oldest batches. In a perpetual record, 'newest' means newest at the date of the issue.
Weighted average cost (periodic)
AVCO per unit = Total cost of opening inventory and purchases ÷ Total units of opening inventory and purchases
Use one average for the whole period when the question asks for it.
Weighted average cost (perpetual)
New AVCO per unit = Cost of inventory on hand after receipt ÷ Units on hand after receipt
Recalculate after every receipt. Issues do not change the average per unit.
Value of an issue
Cost of issue = Units issued × Price of the units issued
Under FIFO and LIFO the issue may use more than one price.

How to solve Accounting for Materials: Inventory Valuation (FIFO, LIFO, AVCO) questions

Use this method for any question on pricing issues or valuing closing inventory.

  1. 1Read which method the question asks for and whether it wants issues, closing inventory or profit.
  2. 2List opening inventory, receipts and issues in date order, with units and unit prices.
  3. 3Work out the units in stock after each transaction. Closing units = opening + receipts − issues.
  4. 4For FIFO or LIFO, take each issue from the correct batch. Reduce the batch and carry any remainder forward.
  5. 5For AVCO, divide total cost by total units. In a perpetual record, recalculate after each receipt.
  6. 6Value closing inventory from the batches left, or at the average price times the units left.
  7. 7Check that opening inventory plus purchases equals cost of issues plus closing inventory.
  8. 8If the question asks about profit, link the answer to price movements: a lower cost of issues means a higher profit.

Quickest way: Total-cost shortcut for closing inventory

When to use it: Use it when the question asks for closing inventory or cost of issues only and all receipts come before the issues.

  1. Calculate total cost available: opening inventory plus all purchases.
  2. Value closing inventory first, as it is often the smaller number. For FIFO, use the newest batches. For LIFO, use the oldest. For AVCO, use the average price.
  3. Subtract closing inventory from total cost available to get the cost of issues.
  4. Check units: units issued plus closing units must equal units available.
  5. If receipts and issues are mixed in date order, do not use this shortcut for LIFO or perpetual AVCO. Work through each transaction.

Common mistakes in Accounting for Materials: Inventory Valuation (FIFO, LIFO, AVCO)

  • Averaging the unit prices instead of weighting them

    Adding $10, $12 and $14 and dividing by 3 looks quicker.

    Fix: Divide total cost by total units. Batches of different sizes carry different weight.

  • Mixing up which batch is left in closing inventory

    Students remember the issue order but forget it determines what remains.

    Fix: Under FIFO the closing inventory is the newest cost. Under LIFO it is the oldest cost. Write the remaining batches down.

  • Using LIFO prices from after the issue date

    Students take the newest purchase in the whole period, even if it arrived after the issue.

    Fix: In a perpetual record, use only batches on hand at the issue date. Go in date order.

  • Not recalculating AVCO after each receipt

    Students keep the old average and apply it to later issues.

    Fix: After every receipt, divide the new total value by the new total units. Issues leave the average unchanged.

  • Stating the profit effect the wrong way round

    Students memorise the rising-price result and apply it when prices are falling.

    Fix: Work out the cost of issues first. The lower the cost of issues, the higher the profit, whatever the price trend.

  • Not checking the total

    Time pressure leads students to skip it.

    Fix: Add cost of issues and closing inventory. It must equal opening inventory plus purchases. This takes ten seconds.

Worked examples

Example 1

A store holds 100 units of material at $10 each. It buys 200 units at $12 and then 100 units at $14. It then issues 250 units to production. All purchases are before the issue. Calculate the cost of the issue and the closing inventory under FIFO, LIFO and AVCO.

Show the solution
  1. Total cost available: 100 × $10 = $1,000, plus 200 × $12 = $2,400, plus 100 × $14 = $1,400. Total $4,800 for 400 units. Closing units are 400 − 250 = 150.
  2. FIFO issue: 100 × $10 = $1,000 plus 150 × $12 = $1,800. Cost of issue is $2,800. Closing inventory is 50 × $12 = $600 plus 100 × $14 = $1,400, which is $2,000. Check: $2,800 + $2,000 = $4,800.
  3. LIFO issue: 100 × $14 = $1,400 plus 150 × $12 = $1,800. Cost of issue is $3,200. Closing inventory is 50 × $12 = $600 plus 100 × $10 = $1,000, which is $1,600. Check: $3,200 + $1,600 = $4,800.
  4. AVCO: $4,800 ÷ 400 = $12 per unit. Issue is 250 × $12 = $3,000. Closing inventory is 150 × $12 = $1,800. Check: $3,000 + $1,800 = $4,800.
  5. Profit effect: prices are rising, so FIFO has the lowest cost of issue and the highest profit. LIFO has the highest cost and the lowest profit.

Answer: Cost of issue / closing inventory: FIFO $2,800 / $2,000; LIFO $3,200 / $1,600; AVCO $3,000 / $1,800.

Example 2

A business uses perpetual AVCO. It holds 200 units at $5 each. On day 5 it receives 300 units at $6. On day 10 it issues 400 units. On day 15 it receives 200 units at $8. On day 20 it issues 150 units. Calculate the total cost of issues and the closing inventory value.

Show the solution
  1. After day 5: units 200 + 300 = 500. Value $1,000 + $1,800 = $2,800. AVCO is $2,800 ÷ 500 = $5.60.
  2. Day 10 issue: 400 × $5.60 = $2,240. Stock left is 100 units, value $2,800 − $2,240 = $560.
  3. After day 15: units 100 + 200 = 300. Value $560 + $1,600 = $2,160. AVCO is $2,160 ÷ 300 = $7.20.
  4. Day 20 issue: 150 × $7.20 = $1,080. Stock left is 150 units, value $2,160 − $1,080 = $1,080.
  5. Total cost of issues is $2,240 + $1,080 = $3,320.
  6. Check: opening $1,000 + purchases $1,800 + $1,600 = $4,400. Issues $3,320 + closing $1,080 = $4,400.

Answer: Total cost of issues is $3,320 and closing inventory is $1,080 (150 units at $7.20).

Exam tips

  • Write a small stores record with date, units and value columns. Do not do it in your head. Most marks are lost through slips in the middle.
  • Read whether the question uses periodic or perpetual valuation. Periodic uses one average for the period. Perpetual recalculates after each receipt.
  • In multiple-response questions on profit effects, check the price trend first. Rising prices: FIFO gives the highest profit. Falling prices: LIFO gives the highest profit.
  • For number entry, check the rounding instruction. Keep unit prices unrounded in your workings and round only the final answer.
  • Use the total-cost check on every question. It catches most errors quickly.

Practice questions from Accounting for material, labour and overheads

Accounting for Materials: Inventory Valuation (FIFO, LIFO, AVCO) in other exams

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

Accounting for Materials: Inventory Valuation (FIFO, LIFO, AVCO): frequently asked questions

What is the difference between FIFO and LIFO?

FIFO charges issues at the oldest prices and leaves the newest prices in closing inventory. LIFO charges issues at the newest prices and leaves the oldest prices in closing inventory. When prices change, they give different profits.

How do you calculate weighted average cost?

Divide the total cost of the inventory on hand by the number of units on hand. In a periodic method, include opening inventory and all purchases. In a perpetual method, recalculate after every receipt.

Which method gives the highest profit?

It depends on price movements. When prices are rising, FIFO gives the highest profit because it has the lowest cost of issues. When prices are falling, LIFO gives the highest profit.

Can I use LIFO for financial statements under IFRS?

No. IAS 2 does not permit LIFO. It still appears in management accounting questions because it shows how cost flow assumptions change cost and profit.