FIFO LIFO Weighted Average

FIFO LIFO Weighted Average

The weighted average cost of the 300 units available for sale may be calculated as follows:

Total cost of annual inventory = 050= £1. 167 per unit

Total annual units of inventory 300

Hence, the cost of goods sold during the year is £233, whilst the value of the closing inventory is £117. The weighted average cost method is a compromise, therefore, between the extreme points established by FIFO and LIFO respectively.

The effects of different methods of inventory valuation on the calculation of income may be seen in the example given below. For simplicity, it is assumed that the business is considering a change in the method of inventory valuation which gave an opening inventory value of £100.

This simple example shows that the closing inventory may be valued at £130, £100 or £117 depending on the assumptions made about the flow of costs. Three different income figures result from using different inventory valuation methods, namely £80, £50 and £67. It should be remembered that the closing inventory for one year becomes the opening inventory of the following year. Therefore, in the long-term, there will be no difference in the calculation of the net income of the business. It is in the short-term that different inventory valuation methods give different results. This fact emphasizes the significance of any changes in the inventory valuation method used.

LIFO is a method of inventory valuation which is commonly used in the United States but its use in the United Kingdom is prohibited by the Inland Revenue authorities.

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Read on: The Valuation of Current Assets

The valuation of current assets

Current assets consist of cash and other assets, such as debtors and inventories, which are expected to be converted into cash or to be used in the operations of the enterprise within one year. The most complex problems lie in the valuation of the different types of inventories existing at the end of an accounting period. In Part 5, we shall see that closing inventories consist of three types-raw materials, work-in-progress and finished goods. The production process may be viewed as a process of adding value to successive categories of inventories, that is,... see: The Valuation of Current Assets