Inventory valuation: FIFO and weighted average compared

Inventory is valued at cost, using either first-in, first-out (FIFO) or weighted-average cost, and written down if it can only be sold for less than cost. FIFO assumes the oldest units are sold first; weighted average spreads cost evenly across all units. LIFO is not permitted under international standards (IAS 2) or the Egyptian Accounting Standards based on them.

A worked example

A company buys 100 units at EGP 10, then 100 units at EGP 12, then sells 150 units.

• FIFO: the 150 units sold cost 100 × 10 + 50 × 12 = EGP 1,600. The 50 left are valued at 50 × 12 = EGP 600.
• Weighted average: average cost = (1,000 + 1,200) ÷ 200 = EGP 11. The 150 sold cost EGP 1,650; the 50 left are EGP 550.
• Moving weighted average recalculates the average after every purchase instead of once per period, so each sale is costed at the average at that moment. In this example, with both purchases before the sale, the result equals the periodic average.

Which method to choose

• When prices rise, FIFO gives a lower cost of sales and higher profit and stock value; weighted average smooths the effect.
• Use the same method for inventory of a similar nature and use, and apply it consistently from year to year.
• Changing method is a change in accounting policy and needs justification and disclosure.

Lower of cost and net realisable value

At the reporting date, compare each item's cost with its net realisable value: the expected selling price minus the costs to complete and sell it. Damaged, obsolete or slow-moving stock often has to be written down. The write-down is an expense in the period it happens.