Inventory valuation methods are used to calculate the value of closing inventory at year-end. The following three methods are commonly used for this purpose:
1: First In First Out (FIFO)
As the name suggests, the FIFO method assumes that items are sold in the order of receipts i.e. first item received in inventory will be issued for sale first. As a result, the cost of the oldest item in an inventory will be taken as the cost of the item sold.
2: Last In First Out (LIFO)
LIFO is exactly opposite to the FIFO system and assumes that the newest item to be issued for sale first. As a result, the cost of the newest items in inventory would be taken as the cost of the item sold.
3: Weighted Average
The weighted average technique updates the inventory cost per unit after each purchase and sale transaction which is termed as weighted average inventory cost and is taken as the cost of items sold in case of any new sale.
Assume following inventory purchase and sale transactions:
|Feb 1||Inventory purchased 100 units @ $ 15/-|
|Feb 3||Inventory purchased 50 units @ $ 17/-|
|Feb 5||Inventory sold 70 units|
|Feb 8||Inventory sold 60 units|
|Feb 15||Inventory purchased 90 units @ $ 16/-|
|Feb 16||Inventory sold 20 units|
Now we’ll perform inventory valuations under all three systems using this data using perpetual inventory management system: