Skip to content

CFA Level I Exam · Analysis of Inventories

FIFO, LIFO and Weighted Average Inventory Cost Flow Methods

Updated 7 October 2026 · Fact-checked

Inventory cost flow methods decide which unit costs go to COGS and which stay in ending inventory. FIFO sends the oldest costs to COGS, LIFO the newest, weighted average uses the average cost, and specific identification tracks each unit. Total cost of goods available is split between COGS and ending inventory.

Understand Inventory Cost Flow Methods: FIFO, LIFO, Weighted Average

A company buys or makes inventory at different costs during the period. When it sells units, it must decide which costs to expense as cost of goods sold (COGS) and which to keep on the balance sheet as ending inventory. The cost flow method makes that choice. The physical flow of goods does not have to match it.

The basic identity is: beginning inventory + purchases = COGS + ending inventory. The cost of goods available for sale is fixed. A method only changes how that total is split. Over the life of the business, total COGS is the same under every method. The timing differs.

FIFO (first in, first out) assumes the oldest units are sold first. COGS carries old costs and ending inventory carries recent costs. LIFO (last in, first out) assumes the newest units are sold first. COGS carries recent costs and ending inventory carries old costs. Weighted average cost divides cost of goods available by units available and applies that average to both COGS and ending inventory. Specific identification matches the actual cost to each unit sold. It suits unique, high-value items such as art or custom equipment.

When prices rise, FIFO gives lower COGS, higher gross profit, higher net income and higher ending inventory than LIFO. Weighted average falls in between. When prices fall, the ranking reverses. Under LIFO in rising prices, income tax is lower (where tax follows reported LIFO), so cash flow is usually higher. FIFO balance sheet inventory is closer to current cost. LIFO balance sheet inventory can be badly out of date.

IFRS does not permit LIFO. US GAAP does. Questions on LIFO therefore tend to be US GAAP in nature or to ask about comparability between firms. Also know the two recording systems. In a perpetual system, inventory and COGS are updated with every sale. In a periodic system, COGS is found at period end from beginning inventory, purchases and a count of ending inventory. FIFO gives the same result under periodic and perpetual. LIFO and weighted average can differ between the two systems.

Key formulas to remember

Inventory identity
Beginning inventory + Purchases = COGS + Ending inventory
Cost of goods available for sale = Beginning inventory + Purchases. Rearrange to find any missing item.
Weighted average cost per unit (periodic)
Cost of goods available ÷ Units available
Apply this one cost to units sold and units left. In a perpetual system, a new average is recomputed after each purchase.
FIFO
COGS uses oldest costs; ending inventory uses latest costs
Gives the same result under periodic and perpetual systems.
LIFO
COGS uses latest costs; ending inventory uses oldest costs
Allowed under US GAAP, not under IFRS. Periodic and perpetual LIFO can differ.
Rising-price ranking
COGS: LIFO > Average > FIFO; Net income and inventory: FIFO > Average > LIFO
Holds when unit costs rise and inventory levels are stable or growing. Reverses when costs fall.

How to solve Inventory Cost Flow Methods: FIFO, LIFO, Weighted Average questions

Use the same routine for any cost flow question. It keeps you organised and lets you check your answer.

  1. 1Read whether the system is periodic or perpetual, and whether the question is IFRS or US GAAP.
  2. 2List beginning inventory and each purchase in date order with units and unit cost.
  3. 3Find units sold and units remaining. Units available = units sold + units remaining.
  4. 4Compute total cost of goods available for sale.
  5. 5Apply the method. For FIFO, take the oldest layers into COGS. For LIFO, take the newest layers. For average, divide total cost by total units.
  6. 6Compute ending inventory (or COGS) for the method, then check that COGS + ending inventory = cost of goods available.
  7. 7If the question asks about effects, state the direction for COGS, gross profit, net income, inventory and taxes, using the price trend.

Quickest way: Find ending inventory first, then subtract

When to use it: Use it when a question asks for COGS under FIFO or LIFO with several purchase layers and you have little time.

  1. Compute cost of goods available in one pass.
  2. For ending inventory, take only the leftover units. FIFO leftovers come from the newest purchases. LIFO leftovers come from the oldest layers, starting with beginning inventory.
  3. COGS = cost of goods available − ending inventory.
  4. Sanity check with the price trend. In rising prices, FIFO COGS must be the lowest of the three. If your answer breaks that, recheck.
  5. Use the check to eliminate options. Numerical options go from smallest to largest, so the ranking often removes two choices fast.

Common mistakes in Inventory Cost Flow Methods: FIFO, LIFO, Weighted Average

  • Mixing up which end of the layers FIFO and LIFO use for ending inventory.

    Students remember the COGS rule but apply it to the leftover units.

    Fix: Remember FIFO ending inventory holds the newest costs and LIFO ending inventory holds the oldest costs.

  • Using a simple average of unit costs instead of a weighted average.

    Averaging the unit prices feels quicker.

    Fix: Divide total cost of goods available by total units. Unequal purchase sizes make the two answers differ.

  • Assuming LIFO is allowed under IFRS.

    LIFO appears often in textbooks and US company examples.

    Fix: IFRS prohibits LIFO. Allowed IFRS methods are FIFO, weighted average and specific identification.

  • Giving a one-way answer on income and inventory without checking the price trend.

    Students memorise the rising-price result as a universal rule.

    Fix: State the price trend first. When costs fall, LIFO gives higher income and higher inventory than FIFO.

  • Treating periodic and perpetual results as always identical.

    FIFO is identical in both, so students generalise.

    Fix: Only FIFO and specific identification match. LIFO and weighted average can differ, because perpetual systems use the costs on hand at each sale date.

  • Forgetting that total COGS over the whole life of the firm is the same under all methods.

    Students focus on one period only.

    Fix: Methods change timing, not total cost. Differences reverse when inventory is eventually sold or liquidated.

Worked examples

Example 1

A company starts the period with 100 units at €10. It buys 200 units at €12, then 100 units at €14. It sells 250 units. Using a periodic system, what is COGS under LIFO? Options: A) €2,900, B) €3,200, C) €3,400.

Show the solution
  1. Units available = 100 + 200 + 100 = 400. Units remaining = 400 − 250 = 150.
  2. Cost of goods available = 100 × 10 + 200 × 12 + 100 × 14 = 1,000 + 2,400 + 1,400 = €4,800.
  3. LIFO ending inventory uses the oldest costs: 100 units at €10 = 1,000 and 50 units at €12 = 600, total €1,600.
  4. COGS = 4,800 − 1,600 = €3,200.
  5. Check directly: newest 100 at €14 = 1,400, then 150 at €12 = 1,800, total €3,200.

Answer: B) €3,200

Example 2

Using the same data, what is COGS under weighted average cost (periodic)? Options: A) €2,900, B) €3,000, C) €3,400.

Show the solution
  1. Cost of goods available = €4,800 and units available = 400.
  2. Weighted average cost = 4,800 ÷ 400 = €12 per unit.
  3. COGS = 250 × 12 = €3,000.
  4. Check ranking: FIFO COGS = 100 × 10 + 150 × 12 = 2,800, LIFO = 3,200, so average of €3,000 lies between them, as expected in rising prices.

Answer: B) €3,000

Exam tips

  • Write the rising-price ranking on your scratch paper at the start: LIFO COGS highest, FIFO net income and inventory highest. Use it as a check.
  • Look for the words periodic, perpetual, IFRS and US GAAP in the stem. They change which methods and results apply.
  • Do the ending inventory calculation first. It usually involves fewer units and is quicker.
  • Practise the BA II Plus or HP 12C only for arithmetic. A simple multiply and add chain is enough, so avoid memory mistakes by writing each layer's cost.
  • In effect questions, give the direction for each item separately. Gross profit, taxes, current ratio and inventory turnover can move differently.

Practice questions from Analysis of Inventories

Inventory Cost Flow Methods: FIFO, LIFO, Weighted Average 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 Flow Methods: FIFO, LIFO, Weighted Average: frequently asked questions

What is the difference between FIFO, LIFO and weighted average?

They are different rules for splitting the cost of goods available between COGS and ending inventory. FIFO expenses the oldest costs first, LIFO the newest first, and weighted average uses one average cost per unit. Total cost available is the same under all three.

How does inflation affect FIFO and LIFO financial ratios?

With rising costs, FIFO gives lower COGS, higher profit margins, higher inventory and a higher current ratio. LIFO gives higher COGS, lower profit and lower inventory. Inventory turnover is higher under LIFO because COGS is higher and inventory is lower.

What is the difference between periodic and perpetual inventory systems?

A perpetual system updates inventory and COGS at each sale. A periodic system calculates COGS at period end from beginning inventory, purchases and an ending count. FIFO results are the same under both, while LIFO and weighted average can differ.

Is LIFO allowed under IFRS?

No. IFRS does not permit LIFO. It allows FIFO, weighted average cost and specific identification. US GAAP allows LIFO as well.