Inventory costing – is about costs allocated to value inventory in stock at the end of a reporting period and calculate the costs of sales/gross profit earned in a period. Most operations comprise retail or wholesale operations, using relatively simple inventory costing systems such as FIFO, LIFO or Average Costs, other operations such as manufacturing or servicing/construction use standard or actual costing systems.
Also keep in mind that the general rule in IFRS is that inventory is measured as the lesser of cost or net realizable value.
For context – Net realizable value
There are a number of different inventory costing methods available for Inventory / Cost of Goods Sold (COGS) valuations/allocations. Perpetual systems continuously update the inventory, avoiding issues inherent with periodic based systems. For cost flow, there are three (3) regularly used cost methodologies in the world: FIFO, LIFO, and Weighted-Average Cost (also commonly referred to as Average Cost).
- FIFO or First-In, First-Out, always assigns the cost of the earliest unit available at the time of sale to COGS, regardless of which unit from the inventory pool is used.
- LIFO or Last-In, First-Out, always assigns the cost of the newest unit available at the time of sale to COGS, regardless of which unit from the inventory pool is used.
- Average Cost calculates the cost that is assigned to COGS and inventory each period closing with new units purchased and added to the inventory.
However, there are also more complex inventory costing systems that facilitate the (financial and operational) management of manufacturing and servicing activities, reference is made to standard costs and actual costs.
To visualize the difference of these three systems (FIFO, LIFO and Average Costs) here is a simple case in quantities of one product in inventory only: