Inventory costing methods

Inventory represents a large (if not the largest) portion of assets and, as such, makes up an important part of the balance sheet. It is, therefore, crucial for investors who are analyzing stocks to understand how inventory is valued.
Inventory is defined as assets that are intended for sale, are in process of being produced for sale or are to be used in producing goods.
The accounting method that a company decides to use to determine the costs of inventory can directly impact the balance sheet, income statement and statement of cash flow. There are three inventory-costing methods that are widely used by both public and private companies:

• First-In, First-Out (FIFO) - This method assumes that the first unit making its way into inventory is the first sold.
• Last-In, First-Out (LIFO) - This method assumes that the last unit making its way into inventory is sold first. The older inventory, therefore, is left over at the end of the accounting period.
• Average Cost - This method is quite straightforward; it takes the weighted average of all units available for sale during the accounting period and then uses that average cost to determine the value of COGS and ending inventor.