Companies in nearly every industry use a variety of inventory costing methods as a way of managing their inventory financially. Managing your inventory from a financial perspective helps you make better decisions about how much you pay for items and the overall amount you buy.

In this article, we discuss what inventory costing is, list and define three methods of inventory costing and include examples for each.

**Contents**

**What is Inventory Cost?**

Inventory costing or inventory evaluation allows companies to assign a monetary value to the items in their inventory. A company’s inventory is often its greatest asset and an appropriate measurement to ensure the accuracy of financial statements.

**How is inventory cost determined?**

Determining inventory costs is often done in five steps. Calculating the cost of inventory requires determining the starting and ending values of your inventory and the value of inventory purchased over a period.

The first step is to determine the specific time period in which you need to find the value of your inventory. With the specified time period, identify your initial inventory store. Your beginning inventory is the value of your inventory either at the beginning of the month or the time period you choose.

Once you’ve determined the time period and determined your initial inventory amount, add the cost of purchasing your inventory over the period together. The next step is to physically calculate the cost of the inventory at the end of the period. This is the month-end value of your inventory.

The final set involves calculating the cost of inventory with the following formula:

**Inventory cost = beginning inventory + purchase of inventory – ending inventory**

**What are the Methods for Calculating Inventory Costs?**

There are three main inventory costing methods used by modern businesses. Which they use depends on their industry or what works best for them. Whichever method they choose should stay in place year after year. The three methods are:

**First In, First Out (FIFO)**

First-in, first-out or FIFO is a method in which assets that are produced and acquired first are also sold or used first. Using FIFO assumes that the cost of goods sold ( COGS) income statement includes the asset with the oldest cost. When this happens, you match the remaining inventory assets with the assets the company recently purchased or produced.

When using FIFO as your method of choice, use these calculations:

**COGS = cost of oldest inventory x number of inventory sold**

**Last In, First Out (LIFO)**

Last-in, first-out or LIFO is a method that records the items that were recently produced as the items that were sold first. It charges the cost of the newest product purchased first as COGS and reports the lower cost of the older product as inventory.

When using LIFO as your method of choice, use these calculations:

**COGS = cost of last inventory x amount of inventory sold**

**Weighted average**

Weighted average or weighted average cost (WAC) is a method that determines the amounts going to COGS and inventories through the use of weighted averages. Using this method involves dividing the cost of goods available by the number of units available.

When using WAC as your method of choice, use these calculations:

**WAC per unit = cost of goods available / units available**

**FIFO example**

Use the information in the following table to determine the COGS using the FIFO method:

- Find units available for sale.
- Find the number of units sold.
- Find your final inventory.
- Use the FIFO formula.

**1. Find units available for sale**

Find the number of units available for sale by adding them together. Start with your initial inventory and include all purchases:

**Units available for sale = 65 + 130 + 35 + 75**

**Units available for sale = (65 + 130) + (35 + 75)**

**Units available for sale = 195 + 110**

**Units available for sale = 305**

*There are 305 units available for sale.*

**2. Find the number of units sold**

Find the number of units sold by adding together each sale:

**Units sold = 95 + 115 + 60**

**Units sold = (95 + 115) + 60**

**Units sold = 210 + 60**

**Units sold = 270**

*There were 269 units sold.*

**3. Find your final inventory**

Find your ending inventory by subtracting your units sold from your units available for sale:

**Ending inventory = 305 – 269**

**Ending inventory = 36**

*There are 36 units left in ending inventory.*

**4. Use the FIFO rumus formula**

Use the FIFO formula by entering the information you know. Start by finding the cost of your oldest inventory by multiplying your starting inventory amount by the unit price:

**COGS = cost of oldest inventory X amount of inventory sold**

**COGS = (65 x 15) x 269**

**COGS = 975 x 269**

**COGS = 262.275**

*The cost of the goods sold was $262,275.*

**LIFO example**

Use the information in the following table to determine COGS using the LIFO method:

**1. Determine the latest inventory cost**

When using LIFO, use your starting inventory to determine the cost of your most recent inventory:

**Recent inventory cost = 70 x 15**

**Latest inventory cost = 1,050**

*Your most recent inventory cost is $1,050.*

**2. Find the number of units sold**

Find the number of units sold by adding together each sale:

**Units sold = 40 + 100 + 70**

**Units sold = (40 + 100) + 70**

**Units sold = 140 + 70**

**Units sold = 210**

*There were 210 units sold.*

**3. Use the LIFO rumus formula**

Plug your information from the previous steps into the LIFO formula:

**COGS = cost of inventory X most recent amount of inventory sold**

**COGS = 1,050 x 210**

**COGS = 220,500**

*The cost of the goods sold is $220,500.*

**Example of weighted average**

Use the information in the following table to determine COGS using the weighted average method:

- Determine the cost of each sale.
- Add your sales together.
- Find units available for sale.
- Use the weighted average formula.

**1. Determine the cost of each sale**

Find the cost of the available items by adding together the cost of each sale:

**May 11 sale = 25 x 25**

**May 11 sale = 625**

*The May 11 sale totaled $625.*

**May 15 sale = 30 x 10**

**May 15 sale = 300**

*The May 15 sale totaled $300.*

**May 25 sale = 35 x 30**

**May 25 sale = 1,050**

*The May 25 sale totaled $1,050.*

**2. Add your sales together**

Combine these three totals to find the cost of the available items:

**Cost of goods available = 625 + 300 + 1,050**

**Cost of goods available = 1.975**

*The cost of available items is $1,975.*

**3. Find units available for sale**

Find the number of units available for sale by adding them together. Start with your initial inventory and include all purchases:

**Units Available for sale = (30 + 50) + (15 + 25)**

**Units Available for sale = 80 + 40**

**Units Available for sale = 120**

*There are 120 units available for sale.*

### 4. Use the weighted average formula

Plug your information into the weighted average formula:

**WAC per unit = cost of goods available / units available**

**WAC per unit = 1.975 / 120**

**WAC per unit = 16.49**

*Your weighted average cost per unit is $16.49.*