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Financial Reporting · Inventories and agriculture

FIFO, Weighted Average and Standard Cost under IAS 2

Updated 11 October 2026 · Fact-checked

IAS 2 allows two cost formulas for inventory: FIFO, which assumes the oldest items are sold first, and weighted average, which uses an average unit cost. Standard cost and the retail method are techniques, allowed only if results approximate cost. Calculate closing units, apply the formula, then compare with net realisable value.

Understand Inventory Cost Formulas: FIFO, AWCO and Standard Cost

Inventory is bought or made at different prices through the year. When you sell some units, you must decide which cost goes to cost of sales and which stays in closing inventory. IAS 2 Inventories calls this a cost formula.

IAS 2 permits two formulas: FIFO (first-in, first-out) and weighted average cost (called AVCO or AWCO in many textbooks). Under FIFO you assume the earliest purchases are used first, so closing inventory is valued at the most recent prices. Under weighted average you calculate an average unit cost from opening inventory and purchases, and apply it to units sold and units left.

LIFO is not permitted by IAS 2. Also, if items are not ordinary interchangeable items, such as specific projects or goods segregated for specific jobs, you use specific identification of cost instead. You must use the same formula for all inventories with a similar nature and use to the entity.

Two techniques are allowed for convenience. Standard cost values inventory at predetermined normal levels of material, labour and overheads, based on normal capacity. It must be reviewed regularly and revised if conditions change. The retail method takes the selling price of inventory and reduces it by an appropriate gross margin percentage to estimate cost. It is used in retail businesses with large numbers of fast-changing items with similar margins. Both are allowed only if the result approximates cost.

Whichever method you use, inventory is finally measured at the lower of cost and net realisable value. In a period of rising prices, FIFO gives a higher closing inventory and a higher profit than weighted average. In falling prices the reverse is true.

Key rules to remember

Inventory measurement
Inventory = lower of cost and net realisable value (NRV)
Apply item by item or to groups of similar items, not to the total of all inventory.
FIFO closing inventory
Closing inventory = latest purchases, taken back until closing units are covered
Cost of sales takes the oldest costs first.
Weighted average cost per unit
(Cost of opening inventory + cost of purchases) ÷ (Opening units + units purchased)
This is the periodic version. Under the perpetual version, recalculate after each purchase.
Net realisable value
NRV = Estimated selling price − estimated costs of completion − estimated selling costs
Compare with cost for each item.
Retail method
Estimated cost = Selling price of inventory × (1 − gross margin %)
Use an appropriate margin for each department. Adjust for marked-down items.
Cost of sales
Opening inventory + purchases − closing inventory
Closing inventory errors flow straight into profit.

How to solve Inventory Cost Formulas: FIFO, AWCO and Standard Cost questions

Use this order for any cost formula question.

  1. 1Read which formula the question requires: FIFO, weighted average, standard cost or retail method.
  2. 2Find the closing units: opening units plus purchases minus sales. Check with the count if given.
  3. 3Apply the formula to value closing units. For FIFO, use the latest purchase prices. For weighted average, use the average cost.
  4. 4Compare cost with NRV for each item or group. NRV is selling price less costs to complete and sell.
  5. 5Take the lower figure as closing inventory.
  6. 6Calculate cost of sales as opening inventory plus purchases less closing inventory, or by costing units sold.
  7. 7State the effect on profit and the statement of financial position if asked.

Quickest way: Layer-and-average shortcut

When to use it: Use for Section A or OT case questions that give a few purchase batches and ask only for closing inventory.

  1. Write the units and cost of each batch in a short list.
  2. For FIFO, start from the last batch and work back until you have the closing units. Multiply and add.
  3. For weighted average, divide total cost by total units, then multiply by closing units.
  4. Check NRV only if the question gives a selling price or costs to sell.
  5. Sanity check: in rising prices, FIFO closing inventory should exceed weighted average closing inventory.

Common mistakes in Inventory Cost Formulas: FIFO, AWCO and Standard Cost

  • Using LIFO because it seems logical.

    Other frameworks or textbooks allow it, and it matches the idea of valuing latest purchases.

    Fix: Remember that IAS 2 bans LIFO. Only FIFO, weighted average or specific identification (for non-interchangeable items) are allowed.

  • Taking the first purchases for FIFO closing inventory.

    Students confuse which layers are sold with which remain.

    Fix: Under FIFO the oldest are sold, so closing inventory is the newest batches. Work backwards from the last purchase.

  • Averaging the prices instead of weighting them.

    Adding unit prices and dividing by the number of batches feels quick.

    Fix: Divide total cost by total units. Batches with more units must carry more weight.

  • Forgetting the NRV test.

    The cost formula calculation feels complete once you have a number.

    Fix: Always ask whether selling price less costs to sell is below cost. If it is, write down inventory to NRV.

  • Using the average cost before the last purchase in a periodic calculation.

    Students mix the periodic and perpetual methods.

    Fix: Read whether the average is recalculated after each receipt. If not stated, a periodic average of the whole period is usual, and your working should state the assumption.

  • Applying the retail method with markup instead of margin.

    Margin is a percentage of selling price, markup a percentage of cost.

    Fix: Check the wording. For margin, multiply selling price by (1 − margin). For markup, divide selling price by (1 + markup).

Worked examples

Example 1

A company had opening inventory of 100 units at ₹20 each. It bought 200 units at ₹24 each, then 200 units at ₹28 each. It sold 350 units. Calculate closing inventory and cost of sales under (a) FIFO and (b) periodic weighted average cost. Ignore NRV.

Show the solution
  1. Closing units = 100 + 200 + 200 − 350 = 150 units.
  2. Total cost = (100 × ₹20) + (200 × ₹24) + (200 × ₹28) = ₹2,000 + ₹4,800 + ₹5,600 = ₹12,400.
  3. FIFO: the 150 closing units come from the latest batch at ₹28. Closing inventory = 150 × ₹28 = ₹4,200.
  4. FIFO cost of sales = ₹12,400 − ₹4,200 = ₹8,200.
  5. Weighted average: total units = 500. Average cost = ₹12,400 ÷ 500 = ₹24.80.
  6. Closing inventory = 150 × ₹24.80 = ₹3,720.
  7. Cost of sales = ₹12,400 − ₹3,720 = ₹8,680.

Answer: FIFO: closing inventory ₹4,200, cost of sales ₹8,200. Weighted average: closing inventory ₹3,720, cost of sales ₹8,680. FIFO gives ₹480 higher profit because prices rose.

Example 2

At the year end, a company holds 400 units of product X at FIFO cost of ₹150 per unit. The selling price is ₹190 per unit. Selling costs are ₹15 per unit. A further 100 units of product Y cost ₹60 each and sell for ₹80 each, with ₹5 selling cost per unit. A retail shop also holds goods at selling price of ₹1,00,000 and earns a 30% gross margin on selling price. State the value of each inventory group.

Show the solution
  1. Product X: NRV = ₹190 − ₹15 = ₹175 per unit. Cost ₹150 is lower, so use cost.
  2. Product X value = 400 × ₹150 = ₹60,000.
  3. Product Y: NRV = ₹80 − ₹5 = ₹75 per unit. Cost ₹60 is lower, so use cost.
  4. Product Y value = 100 × ₹60 = ₹6,000.
  5. Retail method: cost = ₹1,00,000 × (1 − 0.30) = ₹70,000.
  6. Total inventory = ₹60,000 + ₹6,000 + ₹70,000 = ₹1,36,000.

Answer: Product X ₹60,000, product Y ₹6,000, retail goods ₹70,000. Total inventory is ₹1,36,000.

Exam tips

  • In Section A, a layered FIFO or weighted average calculation is typical. Write the batches down before calculating, because a wrong answer scores zero.
  • Know the permitted and banned methods. A question may ask which of four methods IAS 2 does not allow. LIFO is the answer.
  • In Section C, show a clear NRV comparison per product line, then the final inventory figure and the write-down charged to cost of sales.
  • Explain effects on profit when asked. Rising prices mean FIFO gives higher profit than weighted average. Do not claim the opposite.
  • For standard cost and retail method, state the condition: acceptable only if the result approximates cost.

Practice questions from Inventories and agriculture

Inventory Cost Formulas: FIFO, AWCO and Standard Cost in other exams

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

Inventory Cost Formulas: FIFO, AWCO and Standard Cost: frequently asked questions

What is the difference between FIFO and AVCO under IAS 2?

FIFO assumes the oldest inventory is used first, so closing inventory carries the latest costs. AVCO uses a weighted average unit cost for both sales and closing inventory. In rising prices FIFO gives higher profit and higher closing inventory.

Is LIFO allowed under IAS 2?

No. IAS 2 does not permit LIFO. You must use FIFO or weighted average for ordinary interchangeable items, or specific identification for items that are not interchangeable.

When can standard cost or the retail method be used?

They can be used for convenience when the results approximate cost. Standard cost needs regular review against current prices and efficiency. The retail method suits retailers with many fast-changing items with similar margins.

Can a company use FIFO for one product and weighted average for another?

Yes, if the inventories differ in nature or use. Inventories with a similar nature and use should use the same formula. Different geographical locations alone do not justify different formulas.