Advanced Accounting · AS 2 Valuation of Inventory

AS 2 Cost Formulas: FIFO, Weighted Average and Standard Cost

Updated 4 October 2026 · Fact-checked

AS 2 assigns inventory cost by specific identification for items that are not interchangeable, and by FIFO or weighted average for interchangeable items. LIFO is not allowed. Standard cost and the retail method are shortcuts, allowed only if the result approximates cost. To solve, pick the formula, cost the closing units, then compare with NRV.

Understand Cost Formulas: FIFO, Weighted Average and Standard Cost

Once you know what goes into the cost of inventory, the next question is which cost to give each unit when the same item was bought at different prices. A cost formula answers that. It decides how total cost is split between closing stock and goods sold.

Specific identification applies to items that are not ordinarily interchangeable, and to goods or services produced and segregated for specific projects. Each item carries its own actual cost. It is wrong for large numbers of interchangeable items, because you could pick which items to call sold and so manage profit.

For interchangeable items, AS 2 allows only two formulas. FIFO assumes the items bought first are sold first, so closing stock is valued at the latest purchase prices. Weighted average gives every unit the average cost of opening stock plus purchases, worked out periodically or on each new receipt. LIFO is not permitted under AS 2. Use the same formula for all inventories of a similar nature and use.

Two techniques are allowed only for convenience, and only if the result approximates cost. Standard cost uses predetermined costs based on normal levels of materials, labour, efficiency and capacity utilisation. These must be reviewed regularly and revised if conditions change. The retail method suits retailers with many fast-changing items at similar margins. It takes the sales value of closing stock and reduces it by the appropriate gross margin percentage, allowing for goods marked down below original price.

In a price-rising market FIFO gives a higher closing stock and higher profit than weighted average. In a falling market it is the reverse. Whichever formula you use, the final carrying amount is the lower of cost and net realisable value.

Key rules to remember

Weighted average cost per unit (periodic): (Cost of opening stock + Cost of all purchases) ÷ (Opening units + Units purchased); Use this when the question values stock at the end of the period. For a moving average, recompute after every purchase.
FIFO closing stock: Closing units valued at the most recent purchase prices, working backwards; Start from the latest lot and move to earlier lots until all closing units are costed.
Cost of goods sold or issued: Opening stock + Purchases − Closing stock; Cross-check: this must equal the cost of the units issued under the same formula.
Retail method: closing stock at cost: Closing stock at selling price × (100% − gross margin % on selling price); The margin must be a percentage of selling price. If the question gives margin on cost, convert it first.
Rules to remember: Specific identification: non-interchangeable items. FIFO or weighted average: interchangeable items. LIFO: not permitted.; Standard cost and retail method are allowed only if the result approximates cost.
Final carrying amount: Lower of cost and net realisable value; The cost formula gives only the cost. Compare with NRV afterwards, item by item or group by group.

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

Use this order for any numerical or theory question on cost formulas.

1Read which formula or technique the question names. If none is named, check whether items are interchangeable. If not, use specific identification. If yes, choose FIFO or weighted average as asked.
2Write a table of opening stock, each purchase and each issue with units, rate and amount, in date order.
3Find closing units: opening units + purchases − issues. Check this against any count given.
4Cost the closing units. FIFO: take the latest lots first. Weighted average: units × average rate.
5Find cost of goods sold as opening stock + purchases − closing stock, and verify it against the issued units.
6For standard cost or the retail method, state the condition that the result must approximate cost, then compute.
7Compare closing stock with NRV and take the lower, if NRV is given.
8Write the conclusion, including that LIFO is not allowed if the question touches it.

Quickest way: Total-cost shortcut for MCQs and written answers

When to use it: Use it when units and rates are given in a short list and only closing stock or cost of goods sold is asked.

Total the units and the total cost at once. This gives the weighted average rate immediately.
For FIFO closing stock, cost only the last lots needed for closing units. You never need to cost the issues.
Get cost of goods sold by subtraction from the total cost.
In MCQs, if prices rise, FIFO closing stock is greater than weighted average closing stock. Use this to discard options that break the order.
For the retail method, multiply closing retail value by cost percentage. Do not rebuild the whole account.
In written answers, show the table, the formula line and a one-line conclusion. Step marks are given for method even if arithmetic slips.

Common mistakes in Cost Formulas: FIFO, Weighted Average and Standard Cost

Choosing LIFO as an acceptable method under AS 2
LIFO is taught in general accounting and allowed in some other frameworks, so it feels familiar.
Fix: Remember that AS 2 allows only specific identification, FIFO and weighted average. Any LIFO option in an MCQ is wrong.
Using weighted average on opening stock plus purchases but dividing by the wrong units
Students forget to include opening units or divide by units issued.
Fix: Divide total cost of opening stock and purchases by total units available, before any issue.
Costing FIFO closing stock from the oldest lots
Students confuse FIFO on issues with FIFO on closing stock.
Fix: Under FIFO the oldest units are sold, so the closing units come from the newest lots.
Applying the retail method margin on cost instead of on selling price
Questions often say 'profit 25%' without being clear about the base.
Fix: Check the base. If margin is on cost, cost is 100 and selling price is 125, so margin on selling price is 20%.
Treating standard cost as always acceptable
Students remember that it is a permitted technique but skip the conditions.
Fix: State that standards must reflect normal levels, be reviewed regularly, and give a result close to actual cost.
Stopping at cost and ignoring NRV
The question focuses on the formula, so the second test gets forgotten.
Fix: After computing cost, compare with NRV whenever it is given, and carry the lower figure.

Worked examples

Example 1

A trader had 100 units at ₹50 on 1 April. He bought 200 units at ₹56 and later 100 units at ₹60. He sold 250 units during the month. Find closing stock and cost of goods sold under (a) FIFO and (b) weighted average (periodic). Which gives the higher profit?

Show the solution

Units available = 100 + 200 + 100 = 400. Closing units = 400 − 250 = 150.
Total cost = 100 × 50 + 200 × 56 + 100 × 60 = ₹5,000 + ₹11,200 + ₹6,000 = ₹22,200.
FIFO closing stock: latest 100 units at ₹60 = ₹6,000, plus 50 units at ₹56 = ₹2,800. Total = ₹8,800.
FIFO cost of goods sold = ₹22,200 − ₹8,800 = ₹13,400. Check: 100 × 50 + 150 × 56 = ₹5,000 + ₹8,400 = ₹13,400.
Weighted average rate = ₹22,200 ÷ 400 = ₹55.50 per unit.
Closing stock = 150 × ₹55.50 = ₹8,325. Cost of goods sold = ₹22,200 − ₹8,325 = ₹13,875.
Prices are rising, so FIFO has the lower cost of goods sold. FIFO profit is higher by ₹13,875 − ₹13,400 = ₹475.

Answer: FIFO: closing stock ₹8,800, cost of goods sold ₹13,400. Weighted average: closing stock ₹8,325, cost of goods sold ₹13,875. FIFO shows ₹475 more profit.

Example 2

A retailer's goods available for sale at selling price are ₹20,00,000. Opening stock plus purchases at cost are ₹15,00,000. Sales for the period are ₹16,00,000. No markdowns. Find closing stock at cost using the retail method and comment on its use under AS 2.

Show the solution

Closing stock at selling price = ₹20,00,000 − ₹16,00,000 = ₹4,00,000.
Cost percentage = ₹15,00,000 ÷ ₹20,00,000 = 75%. So gross margin is 25% of selling price.
Closing stock at cost = ₹4,00,000 × 75% = ₹3,00,000.
Cost of goods sold = ₹15,00,000 − ₹3,00,000 = ₹12,00,000. Check: 75% of ₹16,00,000 = ₹12,00,000.
AS 2 allows the retail method for convenience in retail trade with many rapidly changing items at similar margins. It is acceptable only if the result approximates cost. If goods were marked down below original price, the percentage must allow for that.

Answer: Closing stock at cost is ₹3,00,000. Cost of goods sold is ₹12,00,000. The method is acceptable only if the result approximates cost.

Exam tips

MCQs often test the ban on LIFO and which method suits which type of item. Learn the rule in one line.
In numericals, show the table of units, rate and amount. Step marks depend on visible working.
Check that opening stock + purchases − closing stock equals cost of goods sold under the same formula.
Read the margin base carefully in retail method questions: on cost or on selling price.
If NRV is given, finish by comparing it with cost and write the lower figure as the carrying amount.

Practice questions from AS 2 Valuation of Inventory

Cost Formulas: FIFO, Weighted Average 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.

Cost Formulas: FIFO, Weighted Average and Standard Cost: frequently asked questions

What is the difference between FIFO and weighted average under AS 2?

FIFO assumes the earliest purchased units are sold first, so closing stock carries the latest prices. Weighted average gives every unit the average cost of opening stock and purchases. In rising prices FIFO gives a higher closing stock and profit.

Is LIFO allowed under AS 2?

No. AS 2 permits only specific identification, FIFO and weighted average for assigning cost. LIFO is not an accepted cost formula under AS 2.

When can standard cost or the retail method be used?

Both are allowed for convenience if the result approximates cost. Standard cost needs standards based on normal levels and reviewed regularly. The retail method suits retailers with many fast-changing items at similar margins.

When is specific identification used?

It is used for items not ordinarily interchangeable, and for goods or services produced and segregated for specific projects. Each item carries its own actual cost. It is not suitable for large numbers of interchangeable items.