subject: FIFO, LIFO, or Weighted Average, Which One to Use? [print this page] In Financial accounting, you will learn many things from double-entry accounting to depreciation. Although most things in financial accounting are important, one of the most important is inventory accounting. Inventory accounting is just a way to calculate, when selling goods which goods and how much you sell the items for. There are three basic ways of going about inventory accounting; FIFO, also known as first-in first-out, LIFO, which is also called last-in first-out; and weighted average. All of the techniques are accepted by Generally Accepted Accounting Principles (GAAP).
FIFO
FIFO, or first-in first-out, which means that the oldest things, or first things in your inventory are the first to be sold to other companies. FIFO makes sure that the most recent purchases are the last things in the inventory. This technique will have the lowest amount of cost of goods sold and it will have the highest net income and gross profit. An advantage of it is that it approximates the current cost on the balance sheet.
LIFO
LIFO, or last-in first-out, which means that the newest things, or the last thing in your inventory are the first to be sold to companies. LIFO actually gives you a slight break on some tax including income tax. The down side though is that it has the highest amount of cost of goods sold and it will have the lowest net income and gross profit. It also is better than FIFO meaning that it better matches revenues with current costs, which makes it better for computing gross profit.
Weighted Average
Weighted average is when you sell your merchandise for the average cost per unit. This is done by adding up the different costs per unit then dividing by the total amount of merchandise inventory. If the merchandise is being sold quickly it can actually resemble FIFO in a way. Weighted average is in between FIFO and LIFO in gross profit, net profit, and cost of goods sold.
Every company uses a different technique of the three to figure out their merchandise inventory, and that why it is important to learn all three, FIFO, LIFO, and weighted average. It is also good to know that all three of these techniques are accepted by GAAP.
FIFO, LIFO, or Weighted Average, Which One to Use?
By: Gary Kleinschmidt
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