Average Cost vs. FIFO Inventory Valuation in QuickBooks
I have written several articles about QuickBooks® Enterprise: 27 Favorite Features in QuickBooks Enterprise That Aren’t in QuickBooks Online Plus, New Features in QuickBooks Enterprise 15 and Why Upgrade to QuickBooks Enterprise Solutions 15, and in most of them, I talk about FIFO Inventory Valuation. But, what exactly does that mean?
Well, let’s start by defining Average Cost, which is the default Inventory Valuation Method of QuickBooks Pro, Premier, Mac, Accountant and QuickBooks Enterprise.
Under the Average Cost Method, it is assumed that the cost of inventory is based on the average cost of the goods available for sale during the period. The average cost is computed by dividing the total cost of goods available for sale by the total units available for sale. This gives a weighted average unit cost that is applied to the units in the ending inventory.
Example: If I buy 1 item at $5 on 06/10/2015, and then I buy the SAME item for $10 on 06/20/2015, all sales of this item made on or after 06/20/2015 will cost $7.5.
FIFO, on the other hand, is defined as the following: FIFO stands for first-in, first-out, meaning that the oldest inventory items are recorded as sold first, but does not necessarily mean that the exact oldest physical object has been tracked and sold. In other words, the cost associated with the inventory that was purchased first is the cost expensed first. With FIFO, the cost of inventory reported on the balance sheet represents the cost of the inventory most recently purchased.
Example: If I buy 10 items at $5 each on 06/10/2015 and then I buy 10 of the SAME items for $10 on 06/20/2015; The first 10 items sold will be costed at $5 each and the next 10 at $10 each.
I really like this graph from the Financial Accounting Blog, illustrating how the purchases relate to the cost of the sales:
And, also, this one, illustrating how items cost based on the method (LIFO is not defined or explained here, because it isn’t available in Quickbooks):
I believe these examples are best illustrated on my YouTube video.