Stock valuation: weighted average, FIFO, LIFO… which method should you choose?

Why value your stock

Stock is tied-up cash. Its value is used for three things:

• calculating the cost of each issue, and therefore the cost of sales and the real margin;
• preparing the balance sheet: closing stock is an asset, and its change affects profit;
• management: value tied up per warehouse or category, slow-moving stock, stock count variances in dinars.

If you always buy at the same price, the question does not arise. But as soon as the purchase price changes from one delivery to the next, you must decide at what price items leave stock: that is the valuation method.

What the cost of an item includes

The acquisition cost of a purchased item includes:

• the purchase price excluding recoverable taxes (deductible VAT is not part of it);
• costs directly linked to the purchase: transport, handling, customs duties and import costs;
• minus trade discounts, rebates and allowances received.

For a manufactured product, the production cost adds labour and production overheads to the cost of materials consumed.

Weighted average cost (WAC)

The weighted average cost (PMP or CMUP in French) averages the prices of the items in stock, weighted by quantity. All issues leave at this average price.

WAC = (stock value + receipt value) ÷ (quantity in stock + quantity received)

There are two ways to calculate it:

• after each receipt (perpetual): the average is recalculated at every delivery, and issues leave at the current average. This is the most accurate method and the one used by management software;
• at period end (periodic): a single average for the month or year (opening stock and all receipts), applied to all issues of the period. Simpler by hand, but the cost of issues is only known at the end.

WAC smooths out price changes: a one-off rise or fall is spread across the whole stock.

FIFO (first in, first out)

FIFO assumes that items leave in the order they came in: the oldest batch is used up first, at its own price, before moving on to the next one.

As a result, the remaining stock is valued at the most recent purchase prices, close to market prices. FIFO also matches the physical reality of many products (food, cosmetics, pharmacy), where the oldest must leave first.

LIFO, and why it is not permitted

LIFO (last in, first out) issues the most recently received items first. When prices rise, it inflates the cost of sales and undervalues the stock on the balance sheet, sometimes at very old prices.

For this reason the international standard IAS 2 prohibits it, and the Algerian Financial Accounting System (SCF), which is based on it, uses weighted average cost and FIFO. LIFO appears below for comparison only.

Special case: non-interchangeable items (serial-numbered machines, vehicles, specific orders) can be valued at their actual cost, item by item (specific identification).

Comparison on the same example

One item, five movements in March, with a rising purchase price:

With WAC (after each receipt)

• 10 March: 150 units for 31,500 DZD, an average of 210 DZD.
• 15 March: issue of 120 × 210 = 25,200 DZD; 30 units remain at 210 DZD (6,300 DZD).
• 20 March: 130 units for 31,300 DZD, an average of 240.77 DZD.
• 25 March: issue of 60 × 240.77 = 14,446.15 DZD; 70 units remain for 16,853.85 DZD.

With FIFO

• 15 March: the 100 units at 200 DZD, then 20 units at 230 DZD, i.e. 24,600 DZD; 30 units remain at 230 DZD.
• 25 March: the 30 units at 230 DZD, then 30 units at 250 DZD, i.e. 14,400 DZD; 70 units remain at 250 DZD (17,500 DZD).

Result

In every case, cost of issues + closing stock = 56,500 DZD, the total of receipts: the method does not change what you paid, only how it is split between the period's sales and the remaining stock. Here, with rising prices, FIFO gives the lowest cost of sales, and therefore the highest margin, and the closing stock closest to current prices.

Which method should you choose?

• WAC suits most shops and distributors: one price per item and per warehouse, easy to read, which absorbs price changes.
• FIFO suits perishable or batch-tracked products, and businesses that want stock valued as close as possible to the latest purchase prices.
• Either way, keep the same method from one year to the next: changing method distorts comparisons and must be justified.

At year-end, if an item can no longer be sold at a price that covers its cost (damaged, outdated, falling market price), an impairment must be recorded to bring the stock down to its realisable value. Confirm your choice and year-end treatment with your accountant.

Stock valuation in Facturelle

• You choose WAC or FIFO in the settings. The choice is made before the first stock movement and is then locked, to respect consistency of methods.
• The average cost is recalculated at each receipt and tracked warehouse by warehouse; each item's stock card shows, line by line, receipts, issues, balance and average cost.
• The cost of each issue is calculated automatically: the margin on sales is accurate, with no manual calculation.
• The valued stock report and stock balance give the stock value at any date, by warehouse or category, exportable to Excel and PDF.
• At stock counts, variances are shown in quantity and in value.

To learn more about day-to-day tracking (warehouses, barcodes, stock counts), read our article on inventory management software.

Frequently asked questions