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First-in, First-out (FIFO): Under FIFO, the cost of goods sold is based upon the cost of material bought earliest in the period, while the cost of inventory is based upon the cost of material bought later in the year. This results in inventory being valued close to current replacement cost. During periods of inflation, the use of FIFO will result in the lowest estimate of cost of goods sold among the three approaches, and the highest net income.(b) Last-in, First-out (LIFO): Under LIFO, the cost of goods sold is based upon the cost of material bought towards the end of the period, resulting in costs that closely approximate current costs. The inventory, however, is valued on the basis of the cost of materials bought earlier in the year. During periods of inflation, the use of LIFO will result in the highest estimate of cost of goods sold among the three approaches, and the lowest net income.(c) Weighted Average: Under the weighted average approach, both inventory and the cost of goods sold are based upon the average cost of all units bought during the period. When inventory turns over rapidly this approach will more closely resemble FIFO than LIFO.
Different valuation methods may produce different "closing inventory" figures that is a part of "cost of goods sold" or "cost of sales" calculation.
In its simplest form, CoS is defined as :
opening inventory + purchases - closing inventory.
If a valuation method produces a greater figuer of closing inventory, CoS would be lower. AND the result would be a higher figure for net profit.
If an inventory valuation method places a lower value to closing inventory, CoS would be greater and profit (gross and net) figure would be low.
(It is worth noting that according to latest accounting standards, we can only use actual unit cost, FIFO and weighted average cost methods to determine the cost of inventory.)
