What are the similarities and differences of the weighted average method and the first in first out method used in process costing?
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FIFO (First in First Out) and weighted average method are inventory valuation methods. Inventory is one of the most vital current assets and some companies operate with significant amounts of inventories. Proper valuation of inventory is essential to show effective results in financial statements. The key difference between FIFO and weighted average is that FIFO is an inventory valuation method where the first purchased goods are sold first whereas weighted average method uses the average inventory levels to calculate inventory value. Show
CONTENTS What is FIFO?FIFO operates under the principle which states that first purchased goods are the ones that should be sold first. In most companies, this is very similar to the actual flow of goods; thus, FIFO is considered to be the most theoretically accurate inventory valuation system among others. E.g. ABC Ltd. is a bookstore that sells study material (books) to universities. Consider the following purchases and related prices for the month of March.
From the total quantity of 4350, assume that 3500 is sold and the sale will be done as follows. 1000 books @ $ 250 = $ 250,000 1500 books @ $ 300 = $ 450,000 500 @ $315 = $ 157,500 Remaining inventory (1350 @ $ 315) = $ 425,250 FIFO is the preferred method by many organizations since the company is not likely to be left with outdated inventory under this method. Companies that use FIFO will constantly have updated market prices reflected in their inventory. The drawback of this method is that this is inconsistent with the prices quoted for customers. Figure 01: Stock Issuance in FIFO What is Weighted Average?This method values inventory by dividing the cost of the goods available for sale by the number of goods, thus calculating an average cost. This helps to arrive at a value that does not represent oldest or latest units. Considering the same example, E.g. Total number of books, 1000 books @ $ 250 = $ 250,000 1500 books @ $ 200 = $ 300,000 1850 books @ $ 315 = $ 582,750 Cost of a book ($ 1,132,750/4350) = $ 260.40 per book Cost of goods sold (3500* $260.40) = $ 911,400 Remaining inventory (1350* 260.40) = $ 351,540 The main advantage of weighted average method is that it evens out effects of widely varying prices due to the average use of price. Further, this is a convenient and simple method of inventory valuation. However, the issue of inventory may not reflect the prevailing economic values. Another disadvantage of this method is that when the average value of inventory is divided by the number of units, this often results in an amount with decimal points that has to be rounded up/down to the nearest whole number. Thus, this does not provide a perfectly accurate valuation. What is the difference between FIFO and Weighted Average?
Summary – FIFO vs Weighted AverageWhile both FIFO and weighted average are popular inventory valuation methods, companies can decide which method to use based on their discretion. The difference between the two depends on the way the inventory is issued; one method sells the goods purchased first (FIFO) and the other calculates the average price for the total inventory (weighted average). The inventory valuation records are internal for the company while its effects will be reflected in the income statement in the cost of goods sold section. References: What is the difference between weighted average and FIFO?The key difference between FIFO and weighted average is that FIFO is an inventory valuation method where the first purchased goods are sold first whereas weighted average method uses the average inventory levels to calculate inventory value.
Which method is better FIFO or weighted average?Impact on financial figures:
In a time of decreasing inflation, the profit margins for a company will be higher under weighted average method as compared to FIFO method because the cost of goods sold will be an average figure under weighted average method which will be lower if costs are recorded under FIFO method.
What is the distinction between equivalent units under the FIFO method and equivalent units under the weighted average method?Answer and Explanation:
It is the sum of units started and finished during the period and the beginning inventory. Under the weighted average method, units started and completed during the period, and the beginning inventory is 100% worked on during the period.
What happens when you change from FIFO to weighted average?If company changes its inventory valuation method from FIFO to weighted average method then it is basically changing the principle of valuation as FIFO follows a particular cost flow assumption whereas weighted average method uses weighted average of the cost at which inventory was held at the beginning of the period ...
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