FIFO, weighted average and stock valuation
The value of your closing stock is the value of your profit, because everything you did not sell is not a cost. That makes the valuation method one of the few accounting choices that directly changes the number at the bottom of the page.
| Method | Cost of sales | Closing stock |
|---|---|---|
| FIFO | 8,000.00 | 12,000.00 |
| Weighted average | 10,000.00 | 10,000.00 |
The methods and their effects
FIFO
The oldest stock is treated as sold first, so cost of sales reflects older prices and closing stock reflects recent ones. In a rising market this reports a higher profit and a higher stock value.
Weighted average
All units of an item carry the same average cost, recalculated as stock arrives. It smooths price movements and is simpler to operate at volume.
LIFO is not permitted
Last-in-first-out is not an acceptable method under Indian accounting standards or IFRS, whatever a spreadsheet might allow.
Lower of cost or net realisable value
Stock is carried at cost unless it is worth less than that, in which case it is written down. Obsolete stock sitting at cost is a common misstatement.
What goes into cost
Purchase price plus freight, duties and other costs of bringing the stock to its present location and condition — not just the invoice value.
Consistency is the real rule
Changing method changes reported profit, so it is not something to do casually. Pick one, apply it, and disclose a change if you make one.
How to decide
- Ask whether units are distinguishable. Batch or serial-tracked goods often suggest specific identification or FIFO; interchangeable bulk goods suit weighted average.
- Consider your price volatility. Where input prices swing hard, weighted average smooths the reported margin; FIFO shows it moving.
- Include the landed cost. Freight and duty belong in stock value, and leaving them out understates both stock and profit.
- Then stop changing it. Consistency is what makes year-on-year comparison mean anything.
Stock valuation questions
Which valuation method should I use?
For interchangeable bulk goods, weighted average is simpler and smooths price swings. For batch or serial-tracked goods, FIFO usually reflects physical reality better. Either is acceptable; what matters more is applying one consistently.
Can I change from FIFO to weighted average?
It is possible but it is a change in accounting policy, it changes your reported profit in the year of change, and it generally needs to be disclosed. It is not a setting to flip because one method gives a nicer number.
Should freight be included in stock value?
Yes — the cost of bringing stock to its present location and condition forms part of its cost, which includes inward freight and duties. Leaving them out understates closing stock and therefore understates profit.
What about stock that will not sell?
It should be written down to net realisable value. Obsolete stock carried at cost is one of the most common misstatements in small-business balance sheets, and it flatters the profit at the same time.
Related
Value it consistently, automatically
tBiz applies your chosen method per item, with closing stock tying to the balance sheet.