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Accounting · Inventories

Cost Formulas under AS 2: FIFO, Weighted Average and Specific Identification

Updated 1 October 2026 · Fact-checked

AS 2 Inventories lets you assign cost to closing stock using specific identification (for unique items), FIFO, or weighted average. FIFO treats the oldest units as sold first. Weighted average uses total cost ÷ total units. To solve, list receipts and issues, apply the chosen method, then find closing stock value.

Understand Cost Formulas: FIFO, Weighted Average and Specific Identification

When a business buys the same item many times at different prices, it cannot tell by looking which price belongs to the unit still in the godown. So AS 2 gives rules for assigning cost to units sold and units left. The choice changes closing stock, cost of goods sold and profit.

Specific identification tracks the actual cost of each item. AS 2 requires it for items that are not ordinarily interchangeable, and for goods or services produced and segregated for specific projects. Think of a custom-built machine or a particular piece of jewellery.

FIFO (First In, First Out) assumes the items bought first are sold first. So closing stock is made up of the latest purchases. In a period of rising prices, FIFO gives a higher closing stock and a higher profit.

Weighted average gives every unit the same average cost. The average is total cost of units available ÷ total units available. It can be worked out periodically (at the end of the period) or on a moving basis (after each purchase).

AS 2 does not list LIFO (Last In, First Out) as a permitted formula. LIFO assumes the newest units are sold first, so closing stock is valued at old prices and may not reflect current cost. Under AS 2 you use FIFO or weighted average for ordinary interchangeable items. A business should use the same cost formula for all inventories of a similar nature and use.

Key rules to remember

Specific identification
Cost of item = actual cost of that identified item
Required for items not ordinarily interchangeable and for goods segregated for specific projects.
FIFO
Closing stock = cost of the latest units purchased, up to the units on hand
Issues are costed from the oldest lot first.
Weighted average cost per unit
(Cost of opening stock + cost of purchases) ÷ (Units of opening stock + units purchased)
Periodic basis: one average for the whole period. Moving basis: recalculate after every purchase.
Closing stock units
Opening units + Purchased units − Issued (sold) units
Check this before costing.
Cost of goods sold
Opening stock + Purchases − Closing stock
Use it to cross-check your answer.
LIFO
Not a permitted cost formula under AS 2
State this clearly if asked.

How to solve Cost Formulas: FIFO, Weighted Average and Specific Identification questions

Use this order for any cost formula question. It keeps your working neat and earns step marks.

  1. 1Read which method the question asks for. If none is stated, check whether items are unique (specific identification) or interchangeable.
  2. 2Draw a table of dates, receipts (units, rate, amount) and issues (units).
  3. 3Compute closing units = opening + purchases − issues.
  4. 4For FIFO, issue from the oldest lot first and carry forward the balance of each lot with its own rate.
  5. 5For weighted average, find the average rate (periodic) or recalculate after each receipt (moving), and apply it to units.
  6. 6Value closing stock = units on hand × cost per unit, or the sum of lot values for FIFO.
  7. 7Cross-check: opening stock + purchases − closing stock = cost of issues.
  8. 8Write the final answer with the method name and, if asked, the effect on profit.

Quickest way: Work backwards from the latest lot for FIFO closing stock

When to use it: Use it when only closing stock value is asked, not each issue.

  1. Find closing units = opening + purchases − issues.
  2. For FIFO, start from the last purchase and take units backwards until you reach closing units.
  3. Multiply each lot taken by its rate and add.
  4. For weighted average (periodic), divide total cost by total units and multiply by closing units.
  5. Verify with cost of goods sold = total cost − closing stock.
  6. Show the table briefly. Marks are given for the working, not only the answer.

Common mistakes in Cost Formulas: FIFO, Weighted Average and Specific Identification

  • Treating LIFO as an allowed method under AS 2

    LIFO is common in textbooks of other countries and in basic theory.

    Fix: Write that AS 2 permits only specific identification, FIFO and weighted average. LIFO is not a permitted formula.

  • Taking the simple average of purchase rates in weighted average

    Students add the rates and divide by the number of lots.

    Fix: Divide total cost by total units. Weights are the quantities.

  • In FIFO, valuing closing stock at the oldest rates

    Confusion between which units are sold and which remain.

    Fix: Under FIFO the oldest are sold, so the units left are the latest purchases.

  • Forgetting to recalculate the average after each purchase in the moving method

    Students apply one average to the whole period.

    Fix: Read whether the question says periodic or moving. In the moving method, update the average after every receipt.

  • Not checking units before costing

    Students rush into rates.

    Fix: Compute closing units first. A mismatch shows an arithmetic slip early.

  • Using one formula for unique items

    Students apply FIFO everywhere.

    Fix: For non-interchangeable items or project-specific goods, use the actual cost of each identified item.

Worked examples

Example 1

A trader had opening stock of 100 units at ₹10 each. On 5 May he bought 200 units at ₹12. On 20 May he bought 100 units at ₹14. During May he sold 250 units. Find the closing stock using FIFO and weighted average (periodic).

Show the solution
  1. Closing units = 100 + 200 + 100 − 250 = 150 units.
  2. Total cost = 1,000 + 2,400 + 1,400 = ₹4,800 for 400 units.
  3. FIFO: closing 150 units come from the latest lots. Take 100 units at ₹14 = ₹1,400, then 50 units at ₹12 = ₹600. Closing stock = ₹2,000.
  4. Weighted average rate = 4,800 ÷ 400 = ₹12 per unit.
  5. Closing stock = 150 × 12 = ₹1,800.
  6. Cross-check FIFO: cost of goods sold = 4,800 − 2,000 = ₹2,800. Issued units: 100 at ₹10 + 150 at ₹12 = 1,000 + 1,800 = ₹2,800. Correct.

Answer: Closing stock: FIFO ₹2,000; weighted average ₹1,800.

Example 2

A firm bought 50 units at ₹20 on 1 June and 30 units at ₹24 on 10 June. It sold 40 units on 5 June and 20 units on 15 June. Find the closing stock using the moving weighted average method.

Show the solution
  1. 1 June: 50 units at ₹20 = ₹1,000.
  2. 5 June: issue 40 units at ₹20 = ₹800. Balance 10 units, ₹200.
  3. 10 June: receive 30 units at ₹24 = ₹720. Balance 40 units, ₹920. New average = 920 ÷ 40 = ₹23.
  4. 15 June: issue 20 units at ₹23 = ₹460. Balance 20 units.
  5. Closing stock = 920 − 460 = ₹460, which equals 20 × 23.
  6. Cross-check: purchases 1,720 − issues (800 + 460 = 1,260) = ₹460.

Answer: Closing stock is 20 units valued at ₹460.

Exam tips

  • Write the units check and a clear table first. Even if arithmetic slips, you earn method marks.
  • Read whether the question says periodic or moving weighted average. The answers differ.
  • If a theory question asks why LIFO is not allowed, say AS 2 does not permit it and that it values closing stock at old costs, which may not reflect current cost.
  • Mention that the same cost formula should be used for all inventories of similar nature and use.
  • Lower of cost and net realisable value is applied after the cost is found. Do not mix the steps.

Practice questions from Inventories

Cost Formulas: FIFO, Weighted Average and Specific Identification: frequently asked questions

Which methods does AS 2 allow?

AS 2 allows specific identification for items that are not interchangeable, and FIFO or weighted average for ordinary interchangeable items. LIFO is not a permitted formula.

Why is LIFO not allowed under AS 2?

LIFO assumes the newest goods are sold first, so closing stock is valued at old costs. This may not show the current cost of stock. AS 2 therefore does not list it as a cost formula.

When is specific identification used?

It is used for items that are not ordinarily interchangeable, such as a custom-made machine. It is also used for goods produced and segregated for specific projects. The actual cost of each item is tracked.

Does FIFO give a higher profit than weighted average?

When prices are rising, FIFO usually gives a higher closing stock and a higher profit, because older, cheaper costs go to cost of goods sold. When prices fall, the effect reverses.