What Is Inventory Valuation Methods (FIFO, Average, Standard)?
Also known as: inventory costing methods, FIFO vs average cost, inventory valuation
Definition
Inventory valuation methods determine the cost assigned to stock on hand and to items sold. The common ones are FIFO, LIFO where allowed, weighted or moving average, specific identification and standard cost.
Inventory Valuation Methods (FIFO, Average, Standard) Explained
FIFO values issues at the oldest layer cost first, so ending inventory reflects recent prices. Weighted or moving average recalculates a single unit cost after each receipt. Standard cost fixes a predetermined cost and sends differences to variance accounts. Specific identification tracks the actual cost of each serial or lot and fits high value or unique items. LIFO is allowed under US GAAP but prohibited under IFRS.
Most ERPs let the method be set per item or item category. SAP uses the price control field in the material master Accounting view: S for standard price and V for moving average price. Business Central offers FIFO, LIFO, Specific, Average and Standard on the item card and uses the Adjust Cost - Item Entries batch job to push actual cost through. NetSuite supports Average, FIFO and LIFO, plus Standard costing for manufacturing. Odoo sets Standard, AVCO or FIFO on the product category. SyteLine items carry a cost type such as Standard, Average, FIFO or LIFO.
The choice affects margins, tax and workload. In rising price markets FIFO shows higher profit than average. Standard costing simplifies shop reporting but demands regular roll-ups. Average costing needs less maintenance but hides variances inside the unit cost.
Changing the method after go-live is an accounting change with audit and tax implications, so it is usually decided before implementation and applied consistently.
Why It Matters
- It changes reported inventory value, cost of goods sold and gross margin for the same physical activity.
- It decides whether you need variance accounts and periodic revaluation or not.
- Tax rules and reporting standards limit which methods can be used in each country.
- Method is a setup decision that is painful to change later in the ERP.
In Practice
Stock: 100 units bought at 10, then 100 at 12. A sale of 150 units costs 1,700 under FIFO (100 x 10 + 50 x 12). With weighted average at 11, the same sale costs 1,650. With standard cost of 11, it costs 1,650 and the 200 total price difference sits in variance accounts.
Frequently Asked Questions
Which inventory costing method is best for manufacturers?
Standard cost is common in repetitive manufacturing for control and variance analysis. Average or FIFO suit companies with volatile prices and less costing staff. The right choice depends on reporting and tax needs.
Is LIFO allowed?
LIFO is permitted under US GAAP and certain tax regimes, but IFRS does not allow it. Check local rules before choosing it.
Can I change the costing method after go-live?
It is possible but is a formal accounting change. It needs revaluation entries, approval and often auditor and tax review, so plan it as a project.
Related Terms
Standard Cost
Standard cost is a predetermined per-unit cost for material, labor, and overhead, set in advance and used to value inventory and transactions. Differences between standard and actual are captured as variances that isolate where cost deviated.
Actual Cost
Actual cost is the real cost incurred to produce or acquire an item, accumulated from the specific material prices paid, labor hours reported, and overhead applied, rather than from a predetermined standard.
Landed Cost
Landed cost is the total cost of bringing purchased goods into inventory, combining the supplier price with freight, insurance, customs duty, tariffs, brokerage, and handling, so inventory is valued at what the material truly cost to acquire.
General Ledger
The general ledger is the central accounting record of a business, where every financial transaction posts as balanced debits and credits against accounts in the chart of accounts, producing the trial balance behind all financial statements.
Cycle Counting
Cycle counting is the practice of continuously verifying inventory accuracy by counting a small subset of items each day or week, rather than shutting down for one annual wall-to-wall physical inventory.
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