FIFO vs. weighted average cost: how do they affect COGS, inventory, and taxes when prices are rising?

Question

AcadiFi · Accepted Answer

Inventory cost flow assumptions determine how you allocate the cost of goods available for sale between COGS (income statement) and ending inventory (balance sheet). Here is the definitive comparison.

**The Core Concept:**

Cost of Goods Available for Sale = Beginning Inventory + Purchases

This total is split into:
- **COGS** (flows to income statement)
- **Ending Inventory** (stays on balance sheet)

The cost flow assumption determines which costs go where.

**Worked Example: Sableridge Electronics**

Sableridge sells circuit boards. Transactions for Q1:

| Date | Units | Unit Cost | Total |
|---|---|---|---|
| Jan 1 (Beginning) | 200 | $40 | $8,000 |
| Jan 15 (Purchase) | 300 | $44 | $13,200 |
| Feb 20 (Purchase) | 250 | $48 | $12,000 |
| Total Available | 750 | — | $33,200 |
| Units Sold | 500 | — | ? |
| Ending Inventory | 250 | — | ? |

**FIFO (First-In, First-Out):**
COGS uses oldest costs first:
- 200 units @ $40 = $8,000
- 300 units @ $44 = $13,200
- COGS = **$21,200**

Ending inventory uses newest costs:
- 250 units @ $48 = **$12,000**

**Weighted Average Cost:**
Weighted avg cost = $33,200 / 750 = **$44.267/unit**
- COGS = 500 x $44.267 = **$22,133**
- Ending Inventory = 250 x $44.267 = **$11,067**

**Summary (Rising Prices):**

| Metric | FIFO | Weighted Avg |
|---|---|---|
| COGS | $21,200 (lower) | $22,133 (higher) |
| Gross Profit | Higher | Lower |
| Ending Inventory | $12,000 (higher) | $11,067 (lower) |
| Income Tax | Higher (more profit) | Lower (less profit) |
| Cash Flow | Lower (more tax) | Higher (less tax) |

```mermaid
flowchart TD
    RP["Rising Prices Environment"] --> FIFO["FIFO"]
    RP --> WA["Weighted Average"]
    FIFO --> F1["Lower COGS"]
    FIFO --> F2["Higher Ending Inventory"]
    FIFO --> F3["Higher Net Income"]
    FIFO --> F4["Higher Taxes = Lower Cash Flow"]
    WA --> W1["Higher COGS"]
    WA --> W2["Lower Ending Inventory"]
    WA --> W3["Lower Net Income"]
    WA --> W4["Lower Taxes = Higher Cash Flow"]
    style RP fill:#c9a84c,color:#0a0a0f,stroke:#c9a84c
    style FIFO fill:#1a1a2e,color:#fff,stroke:#c9a84c
    style WA fill:#1a1a2e,color:#fff,stroke:#c9a84c
```

**Key Points:**
- Under **IFRS**, LIFO is prohibited. The exam focuses on FIFO vs. weighted average.
- **FIFO ending inventory** is closest to current replacement cost (uses newest prices).
- **FIFO COGS** is the most outdated (uses oldest prices).

**Exam Tip:** If prices are rising and the question asks which method results in higher net income, the answer is always FIFO. If it asks about better cash flow, the answer is weighted average (lower taxes).

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FIFO vs. weighted average cost: how do they affect COGS, inventory, and taxes when prices are rising?

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Related Questions

Practice Questions

Date	Units	Unit Cost	Total
Jan 1 (Beginning)	200	$40	$8,000
Jan 15 (Purchase)	300	$44	$13,200
Feb 20 (Purchase)	250	$48	$12,000
Total Available	750	—	$33,200
Units Sold	500	—	?
Ending Inventory	250	—	?

Metric	FIFO	Weighted Avg
COGS	$21,200 (lower)	$22,133 (higher)
Gross Profit	Higher	Lower
Ending Inventory	$12,000 (higher)	$11,067 (lower)
Income Tax	Higher (more profit)	Lower (less profit)
Cash Flow	Lower (more tax)	Higher (less tax)