Inventory Costing Methods: First In First Out (FIFO) or Average Costing?

inventory costing methods

 

Calculating the Cost of Goods Sold (COGS) can be done in many different ways, but two of the most popular inventory costing methods are FIFO and Average Costing.

Both are quite popular, but they vastly differ in they way they arrive at their calculations.

Generally, FIFO methods of accounting are preferred because they present a more accurate picture of cost based on a timeline or fixed period.

FIFO method

FIFO is a management practice that allows business to accurately calculate the value of their inventory given that prices of physical stocks differ and fluctuate over time.

This is especially useful for companies that deal with stocks that have an expiry date, like medicine or food. It assumes that whatever you buy first will be sold first, hence the name ‘First-In-First-Out’.

Average Costing

Contrary to FIFO, Average Costing gives you a COGS value by taking the total cost of all batches of products and dividing by the quantity of goods purchased over a fixed period of time.

Although still used by a large number of companies, this method is fast becoming obsolete because the values are not usable and are often inaccurate. Also, investors and accountants are demanding more

Also, investors and accountants are demanding more real time data as stocktaking practices evolve with time.

Companies use the average costing method because it is simple to execute yet able to give an approximate value of costing over time.

In comparison, FIFO’s method of accounting is complicated and requires a lot of time and effort to derive a value, although it might be more accurate.

If you’re an active trading and distribution company with various products coming in and out of your warehouse frequently, arriving at a FIFO value of cost will be quite impossible, or rather very inefficient, without the use of an inventory management software.

Inventory Costing Methods: Comparing both methods

However here at EMERGE App, we strongly recommend using the FIFO method as companies are looking to leverage more on technology and software’s to work better and have more relevant data on their fingertips.

The complexity of the FIFO calculations gives managers and owners more than just accurate and timely data, it also allows the company to identify and reduce obsolete inventory, reduce the impact of inflation and give an Ending Inventory Value that is up to date with current inventory prices at the time of auditing. More information can be found here

If you’re in need of an inventory management software that allows FIFO capability, try EMERGE App and see what we can do for you. Take advantage of our flexible system and batch

Take advantage of our flexible system and batch labeling features that will enable you to focus on what matters to your business, and ensure that real time and relevant data is always at your fingertips.