Why does inventory costing matter?
When a business buys the same product at different prices over time, it must choose a cost-flow assumption to determine which costs are matched to sales (COGS) and which remain in inventory.
The three main methods — FIFO, LIFO, and Weighted Average — produce different COGS and ending inventory values from identical purchase and sales data, affecting reported gross profit and tax obligations.
Example — Riverside Hardware Store
| Date | Transaction | Units | Cost/Unit | Total Cost |
|---|---|---|---|---|
| Jan 1 | Beginning Inventory | 50 | $10.00 | $500 |
| Jan 10 | Purchase | 100 | $13.00 | $1,300 |
| Jan 25 | Purchase | 80 | $16.00 | $1,280 |
| Total Available | 230 | $3,080 | ||
| Jan 31 | Less: Units Sold @ $25.00 | (160) | Revenue = $4,000 | |
| Ending Inventory Units | 70 | |||
FIFO — First-In, First-Out
The oldest inventory purchased is sold first. Think of a supermarket shelf: new stock to the back, older stock sold from the front. FIFO usually results in lower COGS and higher ending inventory when prices are rising.
Step-by-Step
Ending: 70 units from Jan 25 purchase → 70 × $16.00 = $1,120
COGS
$1,960
Ending Inventory
$1,120
Gross Profit
$2,040
Side-by-Side Comparison
| Metric | FIFO | LIFO | Weighted Avg |
|---|---|---|---|
| Revenue | $4,000 | $4,000 | $4,000 |
| Cost of Goods Sold | $1,960 | $2,320 | $2142.61 |
| Gross Profit | $2,040 | $1,680 | $1857.39 |
| Ending Inventory | $1,120 | $760 | $937.39 |
| Total (COGS + Ending) | $3,080 | $3,080 | $3,080 |
Notice: COGS + Ending Inventory always equals $3,080 — this is your verification check.
Ready to test your knowledge?
Switch to Practice Exercises — choose FIFO, LIFO, or Weighted Average and generate problems at your difficulty level.