FIFO vs Weighted Average: Choosing an Inventory Valuation Method

FIFO vs weighted average is the most common inventory valuation choice Indian businesses face, and it affects reported profit, closing stock in the balance sheet, gross margins by product and even the drawing power your bank allows. Both methods are permitted under Indian accounting standards. LIFO is not. This guide explains how FIFO and weighted average inventory valuation work, with step-by-step rupee examples, how prices rising or falling change the result, what the accounting standards require, and how to choose and apply a method consistently in an ERP.

Why inventory valuation method matters

Cost of goods sold equals opening stock plus purchases minus closing stock. Whatever value you put on closing stock directly changes profit. When purchase prices are stable, the method barely matters. When prices move, as they often do for steel, copper, polymers, edible oils or electronics components, the gap between methods can be material.

The method you choose affects:

• Gross profit and net profit for the period.
• Closing stock in the balance sheet and stock statements submitted to banks.
• Income tax, since taxable profit flows from book profit (subject to the tax law's own rules on valuation).
• Item-level margin reporting and pricing decisions.

What Indian accounting standards allow

AS 2 (Valuation of Inventories), applicable to companies following Indian GAAP, and Ind AS 2, applicable to companies under Ind AS, both require inventory to be measured at the lower of cost and net realisable value. For items that are not specifically identifiable, cost is assigned using:

• FIFO (first in, first out), or
• Weighted average cost.

LIFO is not permitted. Specific identification is required for items that are not ordinarily interchangeable or are segregated for specific projects. The same cost formula should be used for inventories of similar nature and use. Income-tax computation standards also follow the FIFO or weighted average principle; check the current notified standards under the Income-tax Act, 2025 when finalising tax computations.

How FIFO works

FIFO assumes the earliest purchased units are sold first, so closing stock consists of the most recent purchases.

Worked example

Suppose a hypothetical Chennai trader of copper wire has these movements in a month (units in kg):

Date	Transaction	Qty (kg)	Rate (₹/kg)	Value (₹)
1 Oct	Opening stock	500	800	4,00,000
8 Oct	Purchase	1,000	840	8,40,000
15 Oct	Sale	900	n/a	n/a
22 Oct	Purchase	600	880	5,28,000
28 Oct	Sale	700	n/a	n/a

Under FIFO:

• Sale on 15 Oct (900 kg): 500 kg at ₹800 + 400 kg at ₹840 = ₹4,00,000 + ₹3,36,000 = ₹7,36,000.
• Sale on 28 Oct (700 kg): remaining 600 kg at ₹840 + 100 kg at ₹880 = ₹5,04,000 + ₹88,000 = ₹5,92,000.
• Total COGS = ₹13,28,000.
• Closing stock: 500 kg at ₹880 = ₹4,40,000.

How weighted average works

Weighted average assigns each unit the average cost of units available. There are two variants:

• Moving (perpetual) weighted average: the average is recalculated after every receipt. This is what most ERPs use.
• Periodic weighted average: one average for the whole period, calculated at the end.

Moving weighted average for the same data

• After 8 Oct purchase: (₹4,00,000 + ₹8,40,000) / 1,500 kg = ₹826.67 per kg.
• Sale on 15 Oct: 900 x ₹826.67 = ₹7,44,000. Remaining 600 kg at ₹826.67 = ₹4,96,000.
• After 22 Oct purchase: (₹4,96,000 + ₹5,28,000) / 1,200 kg = ₹853.33 per kg.
• Sale on 28 Oct: 700 x ₹853.33 = ₹5,97,333.
• Total COGS = ₹13,41,333. Closing stock: 500 kg x ₹853.33 = ₹4,26,667.

Periodic weighted average

Total available: 2,100 kg costing ₹17,68,000, so average = ₹841.90 per kg. COGS = 1,600 x ₹841.90 = ₹13,47,048. Closing stock = 500 x ₹841.90 = ₹4,20,952.

Comparing the results

Method	COGS (₹)	Closing stock (₹)	Gross profit if sales = ₹15,20,000
FIFO	13,28,000	4,40,000	1,92,000
Moving weighted average	13,41,333	4,26,667	1,78,667
Periodic weighted average	13,47,048	4,20,952	1,72,952

In a rising price environment, FIFO shows a higher profit and higher closing stock, because older, cheaper costs go to COGS. In a falling price environment the opposite happens. Over the life of the business the total profit is the same; the method changes timing.

FIFO vs weighted average: pros and cons

Factor	FIFO	Weighted average
Reflects physical flow	Yes, for perishable and dated goods	Approximates flow for mixed, fungible goods
Closing stock value	Close to current replacement cost	Smoothed across purchases
Profit volatility	Follows price swings with a lag	Smoother
Calculation effort	Needs layer tracking (by lot)	Simple running average
Typical fit	Food, pharma, batch-controlled items	Commodities, liquids, bulk materials, mixed bins

What happens when prices fall

Run the same copper wire example with falling prices: opening stock of 500 kg at ₹880, a purchase of 1,000 kg at ₹840 and a later purchase of 600 kg at ₹800, with the same sales of 900 kg and 700 kg. Total cost available is ₹4,40,000 + ₹8,40,000 + ₹4,80,000 = ₹17,60,000.

• FIFO: closing stock is the last 500 kg at ₹800 = ₹4,00,000, so COGS = ₹13,60,000.
• Periodic weighted average: average cost = ₹17,60,000 / 2,100 = ₹838.10 per kg; closing stock = ₹4,19,048 and COGS = ₹13,40,952.

Now weighted average shows the higher profit, by about ₹19,000. The lesson for owners: neither method is "conservative" in all conditions. FIFO tracks the market with a lag, while weighted average dampens the swings in both directions.

Valuation and your bank stock statement

Businesses with cash credit limits submit monthly stock statements, and drawing power is computed on the stock value declared. Three practical points follow from the valuation method:

• Use the same method in stock statements as in your books. Declaring stock at current market price to the bank while the books use cost creates differences that surface during stock audits and at renewal.
• Exclude or write down old and damaged stock consistently. Banks typically exclude stock beyond a certain age from drawing power anyway.
• Expect stock audits to test valuation. A bank-appointed stock auditor may pick items and trace their rates to purchase invoices. A system that shows the cost build-up for each item makes this quick.

Net realisable value: the step people forget

Whichever cost formula you use, inventory must be written down if net realisable value (estimated selling price minus costs to complete and sell) falls below cost. Damaged goods, obsolete models, near-expiry stock and items whose market price has crashed are the usual cases. Suppose 200 kg of the copper wire above is damaged and can only be sold as scrap at ₹600 per kg net. Under FIFO it is carried at ₹880; the write-down is 200 x (₹880 minus ₹600) = ₹56,000, charged to the P&L. Do this review at least at each reporting date, item by item or by group.

How to choose a method

1. Match the physical flow where it is meaningful. Dated or batch-controlled goods suit FIFO.
2. Consider data granularity. FIFO needs your system to track cost layers or batches. If you cannot track lots reliably, weighted average is more robust.
3. Think about margin reporting. Weighted average gives smoother item margins, which sales teams often find easier to price against.
4. Stay consistent. A change in method is a change in accounting policy, requiring justification and disclosure. Do not switch to manage profit.
5. Talk to your auditor before go-live on a new ERP so the method in the system matches the accounting policy note.

Implementing valuation in an ERP

An ERP with perpetual inventory computes valuation on every movement, which brings practical issues worth settling upfront:

• Landed cost: freight, customs duty and other costs to bring goods to their present location belong in inventory cost. If they arrive after the GRN, the system must revalue the received stock. See our guide on inventory turnover for why accurate values matter.
• Negative stock: if users can sell before the GRN is posted, the system has to guess a cost and correct it later, which distorts valuation. Block negative stock where possible.
• Back-dated entries: a purchase entered with an earlier date after sales have been costed requires recalculation. Good ERPs handle reposting; spreadsheets do not.
• Warehouse level: decide whether the average is computed per warehouse or company-wide. Per warehouse is usually more accurate when freight costs differ by location.

Fininvo's inventory module lists inventory valuation and serial and batch tracking among its features, so the cost method can be applied alongside lot-level traceability.

Frequently Asked Questions

Is LIFO allowed in India?

No. AS 2 and Ind AS 2 permit FIFO or weighted average cost (and specific identification where required), but not LIFO.

Which method gives higher profit, FIFO or weighted average?

When purchase prices are rising, FIFO usually shows higher profit and higher closing stock. When prices are falling, weighted average usually shows higher profit. Over time, the totals converge.

Can I use different methods for different items?

The same cost formula should be used for inventories of similar nature and use. Different formulas can be justified for inventories of genuinely different nature or use, and the policy should be documented.

Can I change my inventory valuation method?

Only if the change results in more appropriate presentation or is required by a standard or statute. It must be disclosed with its effect. Discuss with your auditor before changing.

Does the valuation method affect GST?

No. GST is levied on the transaction value of supplies, not on inventory valuation. The method affects profit and income tax timing, not GST.

How Fininvo Helps

Fininvo ERP maintains perpetual inventory across warehouses with valuation and batch tracking, posting stock movements to the general ledger. Explore inventory, accounting and pricing.