Updated for the 2026-2027 CFA® Level I curriculum.
A company that sells physical goods must decide which cost to assign to each unit sold and which cost stays on the balance sheet as ending inventory. This decision uses one of four inventory valuation methods. Level I tests whether you can calculate cost of goods sold (COGS) and ending inventory under each method and explain how the choice affects the financial statements. This note builds the calculation skills you need before comparing how these methods behave during inflation and deflation.
Quick Answer
The four inventory valuation methods are first-in, first-out (FIFO), last-in, first-out (LIFO), weighted average cost, and specific identification. Each method assigns a different cost to units sold and units remaining in inventory, even when the physical goods are identical. The FIFO method assumes the oldest costs move to cost of goods sold first, while LIFO assumes the newest costs do. These are cost flow assumptions, not descriptions of actual physical movement.
Key Takeaways
FIFO, LIFO, weighted average cost, and specific identification are cost flow assumptions used to assign cost to units sold and units remaining in inventory.
The fifo inventory method assigns the oldest unit costs to cost of goods sold and leaves the most recent costs in ending inventory.
The lifo method does the opposite: the newest costs go to cost of goods sold, and the oldest costs remain in ending inventory.
The weighted average inventory method blends all available costs into a single per-unit cost, used for every unit sold and remaining.
IFRS prohibits LIFO. US GAAP permits it. This distinction appears often on the exam.
The specific identification method of inventory valuation tracks the actual cost of each specific unit and is used for unique, non-interchangeable items.
What You Need to Know for CFA Level I
This foundation note supports the LOS requiring calculation and explanation of price-change effects across inventory methods.
You must compute COGS and ending inventory under FIFO, LIFO, and weighted average cost from the same set of purchase and sale data.
Know that cost flow assumptions do not need to match the physical flow of goods. A company can use FIFO even if it physically ships its newest inventory first.
Keep this page separate from Lower of Cost and Net Realizable Value. This page assigns cost. That sibling note adjusts an already-assigned cost downward when market value falls.
The most common trap is reversing the income effect of a method during rising or falling prices. Practice the direction, not just the formula.
The Four Inventory Valuation Methods
Every unit of inventory available for sale during a period has a cost. When a company sells some units and keeps others, it needs a rule for deciding which costs go to the income statement (as COGS) and which stay on the balance sheet (as ending inventory). That rule is the inventory valuation method.
Method | Cost Assigned to COGS | Cost Assigned to Ending Inventory |
|---|---|---|
FIFO | Oldest costs first | Most recent costs |
LIFO | Newest costs first | Oldest costs |
Weighted average cost | Average cost per unit | Average cost per unit |
Specific identification | Actual cost of unit sold | Actual cost of unit remaining |
FIFO Method
The fifo method assigns the first costs recorded to the first units sold. During the period, oldest costs flow to COGS, and the most recent purchase costs remain in ending inventory. This makes ending inventory under FIFO close to current replacement cost, which is useful for balance sheet analysis.
LIFO Method
The lifo method assigns the latest available costs to the units sold. The newest costs flow to COGS, and the oldest costs remain in ending inventory. Because old costs can sit on the balance sheet for years, LIFO ending inventory often understates current replacement cost. IFRS does not permit LIFO. Only companies reporting under US GAAP can use it.
Weighted Average Cost Method
The weighted average inventory method calculates one average cost per unit from all goods available for sale, then applies that single cost to both units sold and units remaining. This smooths out the effect of price changes compared to FIFO or LIFO.
Specific Identification Method
The specific identification method of inventory valuation assigns the actual, traceable cost of each individual unit. This method fits businesses selling unique, non-interchangeable items, such as custom equipment, real estate, or fine art, where each unit has a distinct cost that can be matched to its sale.
Calculating Cost of Goods Sold and Ending Inventory
All four methods start from the same total: cost of goods available for sale.
Cost of Goods Available for Sale = Beginning Inventory + Purchases
Cost of Goods Available for Sale = Costs of Goods Sold + Ending Inventory
where:
Beginning Inventory: cost of inventory on hand at the start of the period,
Purchases: cost of inventory bought during the period,
Cost of Goods Sold (COGS): cost assigned to units sold, reported on the income statement, and
Ending Inventory: cost assigned to units remaining, reported on the balance sheet.
For weighted average cost, calculate the per-unit cost first.
where:
Cost of Goods Available for Sale: total cost of beginning inventory plus purchases,
Units Available for Sale: total number of units on hand plus purchased during the period.
Working Example
A company sells a single product. Inventory records for the year show:
Date | Transaction | Units | Cost per Unit | Total Cost |
|---|---|---|---|---|
January 1 | Beginning inventory | 100 | $10 | $1,000 |
March | Purchase | 200 | $12 | $2,400 |
September | Purchase | 200 | $14 | $2,800 |
Total available | 500 | $6,200 |
Assume a periodic inventory system. The company sold 300 units during the year. 200 units remain in ending inventory.
FIFO calculation
COGS uses the oldest costs first: 100 units at $10, plus 200 units at $12.
COGSFIFO = (100 × $10) + (200 × $12) = $1,000 + $2,400 = $3,400.
Ending inventory is the remaining 200 units from the September purchase.
Ending InventoryFIFO = 200 × $14 = $2,800.
LIFO calculation
COGS uses the newest costs first: 200 units at $14, plus 100 units at $12.
COGSLIFO = (200 × $14) + (100 × $12) = $2,800 + $1,200 = $4,000.
Ending inventory is the remaining 100 units at $10 and 100 units at $12.
Ending InventoryLIFO = (100 × $10) + (100 × $12) = $1,000 + $1,200 = $2,200.
Weighted average calculation
Prices rose from $10 to $14 during the year. FIFO produces the lowest COGS ($3,400) and the highest ending inventory ($2,800), because it leaves the newest, highest-cost units on the balance sheet. LIFO produces the highest COGS ($4,000) and the lowest ending inventory ($2,200), because it pushes the newest costs straight to the income statement. Weighted average falls in between on every measure. An analyst comparing two companies using different methods must adjust for this before comparing gross margin or inventory turnover.
Common Exam Traps
Treating cost flow as physical flow
A company can use FIFO for accounting purposes while physically shipping its newest stock first. The method is an assumption about cost assignment, not a description of warehouse operations.
Assuming LIFO is available under IFRS
IFRS prohibits LIFO. Only companies reporting under US GAAP may choose it. The exam tests this rule directly, often in a question about comparing an IFRS filer to a US GAAP filer.
Reversing the income effect during rising prices
In a rising price environment, FIFO produces lower COGS and higher net income. LIFO produces higher COGS and lower net income. Candidates often flip this direction under time pressure.
Confusing cost assignment with cost impairment
This note covers how a company assigns cost in the first place. The sibling note on Lower of Cost and Net Realizable Value covers writing an already-assigned cost down when market value drops below cost. These are two separate steps, not the same calculation.
Forgetting that LIFO results can depend on inventory system
Under a periodic inventory system, LIFO is calculated once at period end. Under a perpetual system, LIFO is recalculated after each sale and can produce a different COGS figure. FIFO produces the same result under either system.
Practice Question
During a period of rising prices, a company switches its inventory valuation method from LIFO to FIFO. Holding all other factors constant, which of the following is most likely to increase as a result of this switch?
Cost of goods sold
Ending inventory carrying value
Weighted average cost per unit
Correct Answer: Option B
Explanation: In a rising price environment, FIFO assigns the oldest, lowest costs to COGS and leaves the most recent, highest costs in ending inventory. LIFO does the opposite, assigning the newest, highest costs to COGS and leaving the oldest, lowest costs in ending inventory. Switching from LIFO to FIFO therefore lowers COGS and raises the carrying value of ending inventory.
Option A: Incorrect. COGS falls under FIFO during rising prices because older, lower costs are expensed first. This is the opposite of what the question asks.
Option C: Incorrect. Weighted average cost is a separate method entirely. Switching between LIFO and FIFO has no effect on a weighted average calculation because the company is not using that method.
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FAQs About Inventory Valuation Methods
What is the difference between FIFO and LIFO inventory methods?
FIFO assigns the oldest inventory costs to cost of goods sold and leaves the most recent costs on the balance sheet. LIFO does the reverse, assigning the newest costs to cost of goods sold and leaving older costs in ending inventory.
Is the weighted average inventory method the same as FIFO?
No. The weighted average inventory method blends all available unit costs into one average, applied to every unit sold and remaining. FIFO and LIFO instead assign distinct costs based on purchase date.
When is the specific identification method of inventory valuation used?
It is used when inventory units are unique and non-interchangeable, such as custom machinery, real estate, or individual art pieces, where each item's actual cost can be tracked separately.
Can a company switch between FIFO and LIFO methods?
A company can change its inventory valuation method, but accounting standards require disclosure of the change and its financial statement impact. This note focuses on the mechanics of each method rather than the rules for changing them.
Does CFA Level I test periodic versus perpetual inventory systems?
You should know that FIFO produces the same result under periodic or perpetual systems, while LIFO can produce different results depending on the system used. The exam generally tests this as a conceptual distinction rather than requiring a full perpetual LIFO recalculation.