CFA Program Level I

FIFO vs LIFO vs weighted average inventory: CFA Level I

IAS 2 assigns cost by specific identification for items that are not interchangeable, and by FIFO or weighted average for interchangeable items; LIFO is not one of its formulas. US GAAP also permits LIFO. Inventory is written down when net realisable value falls below cost, and under US GAAP LIFO inventory still uses the lower of cost or market.

What each standard allows

IAS 2 measures inventories at the lower of cost and net realisable value. It assigns cost by specific identification for items that are not ordinarily interchangeable, and by the first-in, first-out (FIFO) or weighted average cost formula for items that are ordinarily interchangeable. LIFO is not among the IAS 2 formulas.

US GAAP permits FIFO, average cost and last-in, first-out (LIFO). ASU 2015-11 moved inventory measured by any method other than LIFO or the retail inventory method to the lower of cost and net realizable value, which more closely aligns US GAAP with IFRS. LIFO and retail-method inventory stayed on the lower of cost or market, where market can be replacement cost, net realizable value, or net realizable value less a normal profit margin.

The three formulas, worked

Example: a company starts with 100 units at USD10, then buys 100 units at USD12 and 100 units at USD14. It sells 200 units. Goods available cost 1,000 + 1,200 + 1,400 = USD3,600.

FIFO: cost of sales = 100 x 10 + 100 x 12 = USD2,200. Ending inventory = 100 x 14 = USD1,400.

LIFO: cost of sales = 100 x 14 + 100 x 12 = USD2,600. Ending inventory = 100 x 10 = USD1,000.

Weighted average: unit cost = 3,600 / 300 = USD12. Cost of sales = 200 x 12 = USD2,400. Ending inventory = 100 x 12 = USD1,200.

With rising prices, LIFO gives the highest cost of sales and the lowest gross profit and ending inventory. FIFO gives the reverse. Weighted average falls between them. In each case cost of sales plus ending inventory equals the USD3,600 available.

Write-downs to net realisable value

Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs to make the sale.

Example: 1,000 units cost USD40 each. Each will sell for USD45, after completion costs of USD3 and selling costs of USD4. NRV = 45 - 3 - 4 = USD38. The write-down is (40 - 38) x 1,000 = USD2,000.

The write-down is an expense in the period it occurs, under both IAS 2 and US GAAP, not when the goods are later sold.

Where the exam catches people

Believing IFRS reporters can choose LIFO: IAS 2 lists only specific identification, FIFO and weighted average.
Believing all US GAAP inventory uses the lower of cost and net realizable value: LIFO and retail-method inventory still use the lower of cost or market.
Believing net realisable value is the selling price: completion costs and selling costs are deducted first.
Believing a write-down is recognised when the goods are sold: it is expensed in the period the write-down occurs.
Believing LIFO gives the higher ending inventory when prices rise: it charges the newest, dearest units to cost of sales and leaves the oldest, cheapest in inventory.

Written from CFA Institute's documentation

Try 3 questions on this

Pick an answer to see why each option is right or wrong.

Torvik ASA reports under IFRS and holds large quantities of interchangeable, individually low-value spare parts. Its finance director has decided against the first-in, first-out formula for these parts. Under IAS 2, the other cost formula Torvik may use for them is:
Right. In the game that’s Renown for your Financial Statement Analysis building.
Not that one: A is right. In the game your Financial Statement Analysis building would lose a little Renown, and this question would come back later.
The answerA.Weighted averageIAS 2 assigns cost by specific identification for items that are not ordinarily interchangeable, and by the first-in, first-out or weighted average cost formula for items that are ordinarily interchangeable, generally large quantities of individually insignificant items.Your answerB.Specific identificationSpecific identification is reserved for items that are not ordinarily interchangeable. Torvik's parts are interchangeable, so IAS 2 points it to first-in, first-out or weighted average.Your answerC.Last-in, first-outLast-in, first-out is used under US GAAP, but IAS 2 names only first-in, first-out and weighted average for interchangeable items, so an IFRS reporter cannot use it.
Show the full explanation and doc quotes
Torvik's spare parts are interchangeable and it has ruled out FIFO, so weighted average is the formula left.
Written from www.ifrs.org/issued-standards/list-of-standards/ias-2-inventories/
Kessler Hardware Inc. reports under US GAAP and measures its inventory using the last-in, first-out (LIFO) method. At year end, selling prices for several of its product lines have fallen well below what the goods cost. For that inventory, Kessler's subsequent measurement is most accurately described as the lower of:
Right. In the game that’s Renown for your Financial Statement Analysis building.
Not that one: C is right. In the game your Financial Statement Analysis building would lose a little Renown, and this question would come back later.
Your answerA.Cost and fair value less costs to sellFair value less costs to sell is not an inventory measure under US GAAP. Under ASU 2015-11, LIFO inventory is measured at the lower of cost or market, with market being replacement cost, net realizable value, or net realizable value less a normal profit margin.Your answerB.Cost and net realizable valueLower of cost and net realizable value is the measure ASU 2015-11 introduced, but the Update states that it does not apply to inventory measured using LIFO or the retail inventory method. Kessler uses LIFO, so its measurement is unchanged.The answerC.Cost or marketASU 2015-11 changed the subsequent measurement of inventory to the lower of cost and net realizable value only for inventory measured by methods other than LIFO or the retail inventory method, such as FIFO or average cost.
Show the full explanation and doc quotes
For inventory measured using LIFO or the retail inventory method, subsequent measurement is unchanged: the lower of cost or market, where market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin.
Written from storage.fasb.org/ASU%202015-11.pdf
Under IAS 2, Meridal SA holds 5,000 units of inventory costing EUR50 each. Each unit is expected to sell for EUR51, after further completion costs of EUR3 per unit and selling costs of EUR2 per unit. The inventory write-down is closest to:
Right. In the game that’s Renown for your Financial Statement Analysis building.
Not that one: C is right. In the game your Financial Statement Analysis building would lose a little Renown, and this question would come back later.
Your answerA.EUR5,000This NRV leaves out the completion costs: 51 − 2 = 49 and (50 − 49) × 5,000 = 5,000. NRV deducts both the costs to complete and the costs to sell.Your answerB.EUR10,000This NRV leaves out the selling costs: 51 − 3 = 48 and (50 − 48) × 5,000 = 10,000. NRV deducts the costs necessary to make the sale as well as completion costs.The answerC.EUR20,000IAS 2 measures inventory at the lower of cost and net realisable value, where NRV is the estimated selling price less costs of completion and costs necessary to make the sale.
Show the full explanation and doc quotes
NRV = 51 − 3 − 2 = EUR46 per unit, below cost of EUR50. Write-down = (50 − 46) × 5,000 = EUR20,000.
Written from www.ifrs.org/issued-standards/list-of-standards/ias-2-inventories/