Inventory, warehouse & supply chain
Inventory valuation methods: FIFO, weighted average and specific identification
FIFO, weighted average and specific identification explained with examples, why LIFO is not allowed under PFRS, net realizable value and system considerations.
Inventory valuation determines the cost assigned to goods sold and to stock remaining at period end. Under PAS 2 (part of the Philippine Financial Reporting Standards), inventories are measured at the lower of cost and net realizable value, and cost is generally determined using FIFO (first-in, first-out) or weighted average cost. Specific identification is used for items that are not interchangeable. LIFO is not permitted under PFRS.
The methods compared
| Method | How it works | Best for |
|---|---|---|
| FIFO | Oldest costs are charged to cost of sales first; ending stock carries the latest costs | Perishables, items with frequent price changes |
| Weighted average | Each unit carries the average cost of available stock, recalculated as purchases arrive | Commodities and interchangeable items in large volumes |
| Specific identification | Each item carries its own actual cost | Vehicles, machinery, jewelry, serialized high-value items |
Worked example
A distributor has these movements for one item in a month:
| Date | Transaction | Units | Unit cost |
|---|---|---|---|
| Oct 1 | Opening stock | 100 | ₱200 |
| Oct 8 | Purchase | 200 | ₱230 |
| Oct 15 | Sale | 180 | |
| Oct 22 | Purchase | 100 | ₱250 |
| Oct 28 | Sale | 120 |
FIFO
- Oct 15 sale of 180: 100 × ₱200 + 80 × ₱230 = ₱38,400
- Oct 28 sale of 120: 120 × ₱230 = ₱27,600
- Cost of sales = ₱66,000; ending stock = 100 units at ₱250 = ₱25,000
Weighted average (moving)
- After Oct 8: (100 × ₱200 + 200 × ₱230) ÷ 300 = ₱220 per unit
- Oct 15 sale: 180 × ₱220 = ₱39,600; remaining 120 units at ₱220
- After Oct 22: (120 × ₱220 + 100 × ₱250) ÷ 220 = ₱51,400 ÷ 220 = about ₱233.64 per unit
- Oct 28 sale: 120 units × (₱51,400 ÷ 220) = ₱28,036.36
- Cost of sales = ₱39,600 + ₱28,036.36 = ₱67,636.36; ending stock = 100 units = ₱23,363.64
Total cost available is the same (₱91,000); the methods split it differently between cost of sales and ending stock. When prices rise, FIFO shows lower cost of sales and higher ending inventory than weighted average.
What is included in cost
Cost includes the purchase price, import duties and non-recoverable taxes, freight and handling to bring goods to their location, less trade discounts and rebates. For manufacturers, it includes materials, direct labor and an allocation of production overhead. See job order costing.
Lower of cost and net realizable value
Net realizable value (NRV) is the estimated selling price less the costs to complete and sell. When NRV falls below cost because items are damaged, obsolete or selling at reduced prices, inventory is written down to NRV. Review slow-moving and damaged stock at least at each reporting date.
Choosing and changing a method
Use the same method for inventories of similar nature and use. A change in method is a change in accounting policy and needs justification and proper disclosure. Agree your method with your auditor and apply it consistently across branches and companies.
System considerations
- The system should compute cost automatically on every receipt and issue, not at month-end in a spreadsheet
- Transfers between branches move cost with the stock
- Returns to suppliers and from customers use the correct cost
- Landed costs (freight, duties) should be added to item cost when known
- Valuation reports must reconcile to the general ledger
Where Cirquolus fits
Cirquolus Inventory management and warehousing include stock valuation, supplier returns and product movement across branches, connected to purchasing and financial management. Related: inventory management systems.
Frequently asked questions
Is LIFO allowed in the Philippines?
LIFO is not permitted under PAS 2 for financial reporting under PFRS.
Which is better, FIFO or weighted average?
Neither is better in general. FIFO suits perishables and changing prices; weighted average suits large volumes of interchangeable items. Choose what reflects your goods and apply it consistently.
What is net realizable value?
The estimated selling price in the ordinary course of business, less estimated costs of completion and costs to sell.
Does valuation method affect taxes?
Valuation affects reported cost of sales and therefore taxable income. Coordinate with your tax adviser on the tax treatment of your chosen method.
Bring this workflow to a Cirquolus demo.
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