FIFO-vs-Weighted-Average-(Inventory-costing-method)

ERPAG 5.1

FIFO vs Weighted Average (Inventory costing method)


In this text, we will not explain the reasons, differences, benefits, etc. between FIFO and average method, we will focus on application and results 

FIFO costing method


What types of cost calculation methods will be used by the companies are chosen among themselves depending on the different parameters and their needs.



In this text, we will not explain the reasons, differences, benefits, etc. between FIFO and average method, we will focus on application and results through ERPAG.



Inventory costing method can be set up for each warehouse differently (through the administration > warehouse list option).

FIFO costing method

Through our example, we will purchase and sell only one item through two different warehouses, one of which is set as FIFO and the other as "Weighted Average".
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1. Purchase orders - receive

We made two purchase orders in each warehouse with one item where the purchase price is $ 50.00 and $ 60.00 (quantity: 10 pcs). And, of course, we "received" the items.

FIFO costing method

FIFO costing method

FIFO costing method

The easiest way to track the changes is through the 'stock card' or 'Inventory / Stock list'.

FIFO costing method

Since the items are just entering our stock, the result is identical.

FIFO costing method

Note: "Receiving" purchase orders and "packing" sales orders make changes in your inventory/stock levels, eg. they are increasing/decreasing the quantity of the items you have in stock.

2. Sales Order - pack

In our case, we will also create two sales orders (per warehouse) where we will sell 10 pcs from each warehouse (the selling price is $ 100.00 without tax).

Now there are differences in the stock card.

FIFO costing method

In the warehouse which has the FIFO costing method, the purchase price used in the sales orders (from which the COGS - Cost of goods sold is formed) is $ 50.00 and $ 60.00.

While at the warehouse which has the average costing price, the purchase price used in both sales orders is $ 55.00, the average purchase price.

Since we have sold the entire purchased quantity, the result looks identical (COGS: $ 1,100.00, Margin amount: $ 900.00), but if viewed individually after sales there is a difference.

The best way to see this is in the stock card as there are additional columns related to the cost difference after each change (margin).

FIFO costing method

In our example, we have a higher margin from the first sale than from the second one.
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3. Sales Order - Sale of goods from two purchases

An example is simple when the sale is divided so that the goods sold belong to one purchase order. The whole quantity has one selling price. What will happen if in our next case the first Sales Order has a quantity of 11 pcs and another Sales Order has a quantity of 9 pcs?

FIFO costing method

There will be an average purchase price for mutual quantities.

FIFO costing method

In our example, 10 pcs will have a price of $ 50, while 1 pcs will have a price of $ 60, and that will make our stock price averaged $ 50.91 (10x50 + 1x60 = 560; 560/11 = $ 50.91).
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4. Retuns, Void

When returning goods or voiding orders, the price taken will always be from the document,  regardless of the method of cost tracking, ie, the stock will be corrected by the price it was purchased/sold.

In our case, the customer will return 1 pcs from our second sales order.
FIFO costing method
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5. Change in stock price / value in inventories

Stock price/value is automatically calculated at the entrance/exit of goods in the warehouse. However, accounting standards envisage the possibility of a correction in special cases (changes of the conditions on the market, adjusting to inflation or season, the need for a more accurate calculation of the selling price, etc.).

Please note that in some national standards this is allowed and in some it is not. Since ERPAG is primarily intended for internal use and not for the official management of business accounting books, we have enabled users to make corrections in a simple way.

We will take our example immediately after receiving the goods from the purchase order.

Stock price is in both warehouse $ 55.00 and quantity 20 pcs. We need to set the stock price to be $ 60.00.
FIFO costing method

We can make the wanted change either through the 'stock adjustment' or directly from the item setup through the 'set quantity' option.
FIFO costing method

In both warehouses we will type in the wanted price ($60 in our example)

FIFO costing method

We will make two sales through the Sales Order, 10 pcs from each warehouse. The result in out stock card is now different.
FIFO costing method

Stock adjustment increased the 'purchase cost balance' and from that moment, each exit of the items will be by the corrected price (in our case for $60).

What we see as a difference is COGS, where now is $1.200,00 while in other examples is $1.000,00. Since we increased our stocks by $100,00 and for the sake of keeping our accounting expenses and income in balance, Stock Adjustment has it's own 'journal voucher'.
FIFO costing method

We increased our supplies by $100,00 and for that amount we have an income (account: Surplus). If we decreased our supplies, the difference would be deficit.
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6. Transfer between warehouses

The transfer between warehouses that have different methods of keeping the stock price is completely supported. The warehouse from which we send the items will have its stock decreased by the method it keeps to calculate his stock price, while the warehouse which receives the items will use their own method of calculating the stock price.

We will transfer 10 pcs from our example (after we received the PO) from the FIFO warehouse to the weighted average warehouse.
FIFO costing method

And we will sell the entire quantity from the weighted average warehouse.
FIFO costing method

Our stock card will now look like this:
FIFO costing method
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7. FIFO in the manufacturing

The principle is identical as with sales, the 'input items' are like Sales Orders (they decrease the stock) while 'output items' act as Purchase Orders (they increase the stock).
FIFO costing method
FIFO costing method

Each work order has information about the estimated cost and actual cost. Depending on the costing method the results may deviate based on the work order, while in overall they will be identical.
FIFO costing method
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8. Summary

Again we must mention that each company has to decide on its own which method will it use, based on its business needs.

Both methods will over a specific amount of time give an identical result.

From our experience, we can only say that if your purchase price are not changing that often, that it's better to use an average costing method. It's faster and easier to control. While, if you are working on the projects where on each sales/work orders you have a need to precisely control the cost, then we are giving an advantage to the FIFO method.

If you have changes in your warehouse, you won't be able to change the costing method.

In that case, we recommend that you open a new warehouse and transfer complete quantity over.
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2019. ERPAG Inc





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