Inventory valuation: FIFO, LIFO and net realisable value

The methods

• FIFO (first in, first out): the oldest goods are assumed to be issued first, so closing inventory is valued at the most recent prices. Realistic for most goods; permitted by IAS 2.
• LIFO (last in, first out): the newest goods are assumed issued first, so closing inventory is at the oldest prices. Cost of sales reflects current prices, but inventory can be badly out of date. IAS 2 does not permit LIFO for financial statements, though it can still be used for internal costing.
• Net realisable value (NRV) = estimated selling price - costs to complete and sell. IAS 2 requires inventory at the lower of cost and NRV, item by item (prudence).

Periodic valuation

With the periodic method, closing inventory is valued once, at the end of the period, from the total purchases. Example: opening 100 units at £5, bought 200 at £6 and 150 at £7, issued 350 units, so 100 units remain.

• Periodic FIFO: 100 units at the latest price £7 = £700.
• Periodic LIFO: 100 units at the earliest price £5 = £500.

Effect on profit and the statement of financial position

When prices are rising:

• FIFO gives higher closing inventory, lower cost of sales and higher profit.
• LIFO gives lower closing inventory, higher cost of sales and lower profit.

When prices fall, the effects reverse. Over the whole life of the business total profit is the same; the method changes the timing. Closing inventory this year is next year's opening inventory, so a higher closing value this year lowers next year's profit. Consistency requires the same method each year.

Worked example

Three items in inventory: A cost £400, NRV £520; B cost £650, NRV £480; C cost £300, NRV £310. Value the inventory.

1. Apply lower of cost and NRV to each item.
2. A: 400. B: 480 (NRV lower). C: 300.
3. Total = 1,180.

Answer: Inventory £1,180, not £1,350 (cost) or £1,310 (total NRV).

Check yourself

1. Opening inventory 40 units at £10. Purchases: 60 at £12, then 50 at £13. 90 units were issued. Value closing inventory using periodic FIFO.
   Show answer

   £770. 60 units remain: the latest 50 at £13 and 10 at £12 = 770.

2. Using the same data (40 at £10, 60 at £12, 50 at £13, 90 issued), value closing inventory using periodic LIFO.
   Show answer

   £640. 60 units remain at the earliest prices: 40 at £10 and 20 at £12 = 640.

3. Goods cost £2,400. They can be sold for £2,500 after repairs costing £350. At what value should they be shown?
   Show answer

   £2150. NRV = 2,500 - 350 = 2,150, lower than cost, so 2,150.

4. In a period of rising prices, closing inventory is £8,600 under FIFO and £7,900 under LIFO. By how much is gross profit higher under FIFO?
   Show answer

   £700. Higher closing inventory lowers cost of sales by the same amount: 700.

5. Which inventory valuation method is NOT permitted by IAS 2 for financial statements?
   • FIFO
   • Lower of cost and net realisable value
   • LIFO
   • Weighted average cost
   Show answer

   LIFO. IAS 2 removed LIFO; FIFO and weighted average are allowed.

6. Prices are rising. Compared with LIFO, FIFO gives
   • higher closing inventory and higher profit
   • lower closing inventory and higher profit
   • higher closing inventory and lower profit
   • the same profit in every year
   Show answer

   higher closing inventory and higher profit. FIFO leaves the newer, dearer goods in inventory, so cost of sales is lower.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting specification (issue 2), Unit 1 and Appendices 6 to 8

Last updated 8 November 2026. Spotted a mistake? Tell us.