Question

Assume the role of a University instructor that is attempting to communicate concepts from the required reading. In 200 words or more, discuss the Weighted Average Method and First In First Out Method, and describe these concepts using examples to illustrate your points.

Answer 1

The FIFO method, LIFO method and Weighted Average Cost method are three ways of valuing your inventory. In this lesson we're going to look at all three methods with examples.

1. The First-In-First-Out Method (FIFO)

This method assumes that the first inventories bought are the first ones to be sold, and that inventories bought later are sold later.

The value of our closing inventories in this example would be calculated as follows:

Using the First-In-First-Out method, our closing inventory comes to $1,100. This equates to a cost of $1.10 per lollypop ($1,100/1,000 lollypops).

It is very common to use the FIFO method if one trades in foodstuffs and other goods that have a limited shelf life, because the oldest goods need to be sold before they pass their sell-by date.

Thus the first-in-first-out method is probably the most commonly used method in small business. Well, probably...

2. The Weighted Average Cost Method

This method assumes that we sell all our inventories simultaneously.

The weighted average cost method is most commonly used in manufacturing businesses where inventories are piled or mixed together and cannot be differentiated, such as chemicals, oils, etc. Chemicals bought two months ago cannot be differentiated from those bought yesterday, as they are all mixed together.

So we work out an average cost for all chemicals that we have in our possession. The method specifically involves working out an average cost per unit at each point in time after a purchase.

In our example above (assuming the weighted average cost method was allowed for valuing the lollypops), the value of our closing inventories would be calculated as follows:

Using the weighted average cost method, our closing inventory amounts to $1,059. This equates to a cost of $1.06 per lollypop ($1,059/1,000 lollypops).

Oddly enough, the LIFO method is the preferred inventory valuation method in the United States but is disallowed in non-US countries. The FIFO method and the weighted average cost method are used in non-US countries. In recent years there have been calls for the standardization of accounting rules throughout the world, and talk specifically about disallowing LIFO in the US (or making the rest of the world follow the LIFO system). As of this writing the matter has not been resolved and the differences in inventory valuation still exist.