Difference between FIFO and Weighted Average Method of Inventory Valuation

Inventory valuation techniques include FIFO (First In, First Out) and weighted mean method. Inventory is among the most important current assets, and some businesses have large inventories. Inventory value is critical for displaying successful outcomes in accounting records.

When it relates to accounting for inventory, organizations might utilize one of three basic accounting methodologies: weighted average cost accounting, last-in, first-out (LIFO) financial reporting, or first-in, first-out (FIFO). However, this article only compares two methods of accounting: FIFO and weighted average cost accounting.

FIFO vs Weighted Average Method of Inventory Valuation

The main difference between the FIFO and weighted average method of inventory valuation is that FIFO is a stock valuation approach in which the first acquired commodities are liquidated first, while the weighted mean technique calculates inventory value using average levels of inventory. Whenever it comes to accounting for stock, firms normally employ one of two basic advantages over paper records: the weighted average technique, the first-in, first-out (FIFO) method, or both.

FIFO vs Weighted Average Method

FIFO stands for First In, First Out. The first in-first out (FIFO) approach is a methodology in which items are sold or issued from the business based on the oldest stock in hand, often known as first in. In a situation involving perishable commodities, this is the most appropriate strategy since the earliest inventory is handled first, lowering the chance of perishable nature.

The FIFO approach is used to estimate expense flows. As goods proceed to the subsequent stage of growth and final inventory items are sold, the accompanying expenses with that product should be recorded as an expense.

The weighted average method on the other hand is also used quite a lot for inventory valuation. A weighted average is a computation that considers the relative value of the integers in a data collection. Before actually performing the final computation on a weighted average, each value in the set of data is amplified by a predefined weighted average. A weighted mean can be more precise than a basic mean, which assigns the same weight to all integers in a data collection.

Comparison Table Between FIFO and Weighted Average Method of Inventory Valuation

Parameters of ComparisonFIFOWeighted Average Method
DefinitionThe first in-first out (FIFO) approach is a methodology in which items are sold or issued from the business based on the oldest stock in hand.The weighted average method on the other hand is also used quite a lot for inventory valuation.
Full FormFirst in, first out.A technique of inventory costing that allocates average prices to each piece of inventory.
No full form.
Method DescriptionFIFO is a system of valuation of inventory in which the first acquired commodities are sold first.The weighted average approach calculates inventory value based on average inventory levels.
Usage FrequencyThe most prevalent inventory valuation approach is first in, first out (FIFO).The weighted average approach is used less frequently than FIFO.
InventoryInventory will be distributed based on the oldest batches that are still available.To arrive at a pricing, inventory will be pooled.

What is FIFO?

Initially, first-out (FIFO) is a system of wealth management and evaluation in which assets generated or obtained first is leased, utilized, or disposed of first. For tax reasons, FIFO presupposes that investments with the oldest expenses will be included in the cost of sales on the financial statements. The leftover stock assets are linked to some of the most recently acquired or generated assets.

The concept of first-in, first-out (FIFO) stipulates that the products acquired first will be sold first. This is highly comparable to the measured value of items in most firms; hence, FIFO is regarded to become the most conceptually precise inventory valuation technique among others.

Many firms favor FIFO because the corporation is less likely to be left with obsolete inventory when using this strategy. Companies that adopt FIFO will always have the most recent market values reflected in their inventories. The disadvantage of this strategy is that it contradicts the pricing offered to clients.

The FIFO approach is used to estimate expense flows. As items advance to subsequent stages and completed inventory goods are sold, the overheads with that product should be recognized as an expense. The value of inventory acquired first is considered to be recognized under the FIFO, lowering the dollar amount of financial inventory.

What is the Weighted Average Method of Inventory Valuation?

All numbers are regarded identically and given equal weight when computing a simple average, also known as an arithmetic mean. A weighted average, on the other hand, provides weights that establish the relative value from each data point in preparation.

A weighted average is commonly used to balance the distribution of entries in a data collection. For instance, a study can collect enough replies from each age group to be scientifically accurate, but the 18-34 age range may have fewer responders than most concerning their population percentage. The questionnaire survey may moderate the findings of the 18-34 age group so that their perspectives are properly reflected.

Typically, investors establish a stake in a company over several years. This makes it difficult to keep track of the fee basis of such units and their respective value fluctuations.

A weighted sum of the stock amount paid for the securities can be calculated by the buyer. To do just that, count the number of shares purchased at each cost by the value, add the entire value, and afterward divide the result value by the number of shares outstanding.

Main Differences Between FIFO and Weighted Average Method of Inventory Valuation

  1. FIFO is an acronym that stands for first in, first out whereas the weighted average method of inventory does not have any full form.
  2. FIFO is more commonly used for inventory evaluation when compared to the weighted average method of inventory valuation.
  3. FIFO is a system of valuation of inventory in which the first acquired commodities are sold first whereas the weighted average approach calculates inventory value based on average inventory levels.
  4. The FIFO method is user-friendly and easy to apply whereas the weighted average method is complicated and less efficient.
  5. In FIFO, the inventory technique will issue the cost from the oldest accessible batch, while the average weighted approach will be balanced out by the price.

Conclusion

While both FIFO and weighted average are common stock valuation methodologies, businesses can use whichever approach they like. The distinction between the two is determined by how inventory is issued; one technique sells the commodities bought first (FIFO), while the other estimates the average price for the complete inventory (weighted average). The inventory valuation data are maintained internally by the firm, and the impacts will be represented in the income statement under the cost of goods sold column.

References

  1. https://gocardless.com/guides/posts/what-is-fifo/
  2. https://corporatefinanceinstitute.com/resources/knowledge/other/weighted-mean/
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