Corporate Finance

Inventory Valuation Methods: FIFO vs Weighted Average Under Ind AS 2

Q: What inventory valuation methods are permitted under Ind AS 2?

Ind AS 2 (and AS 2 under the earlier framework) permit the First-In-First-Out (FIFO) method and the weighted average cost method for valuing inventory. The Last-In-First-Out (LIFO) method is not permitted under Ind AS 2 or AS 2, although it remains permitted under some other accounting frameworks such as US GAAP. Whichever method is chosen, the same cost formula must be applied to all inventories having a similar nature and use to the entity, and the choice must be disclosed and applied consistently from period to period.

Q: How does the choice between FIFO and weighted average affect profit during inflation?

During a period of rising prices, FIFO assumes the oldest (cheaper) inventory is sold first, so cost of goods sold reflects older, lower costs while closing inventory is valued at more recent, higher costs — this results in higher reported gross profit and a higher closing inventory value compared to weighted average. The weighted average method blends old and new costs together, producing a cost of goods sold and closing inventory value that sit between the FIFO and (hypothetical) LIFO outcomes. Neither method is 'more correct' — they simply make different assumptions about which costs flow to the income statement first.

Q: What is net realisable value and when does it matter for inventory?

Net realisable value (NRV) is the estimated selling price of inventory in the ordinary course of business, less estimated costs of completion and estimated costs necessary to make the sale. Ind AS 2 requires inventory to be carried at the lower of cost and NRV. If NRV falls below the cost determined by FIFO or weighted average — for example, due to damage, obsolescence, or a fall in selling prices — the inventory must be written down to NRV, with the write-down recognised as an expense in the period it occurs.

FININ2MIN RESEARCH Updated Jun 2026 · 7 min read

Two finance teams can buy and sell the exact same inventory, in the exact same quantities, at the exact same prices — and still report different gross profit. The reason: how they assume inventory "flows" through the warehouse for costing purposes.

The Two Permitted Methods Under Ind AS 2

Method	Assumption	Effect During Rising Prices
FIFO (First-In-First-Out)	The oldest stock (bought first) is sold first; closing inventory consists of the most recently purchased units	Lower COGS, higher gross profit, higher closing inventory value (at recent, higher costs)
Weighted Average Cost	All units in inventory are costed at a single blended average cost, recalculated as new purchases are made	COGS and closing inventory both reflect a blend of old and new costs — smoother, less extreme than FIFO

⚠ LIFO is not permitted. Last-In-First-Out (LIFO) is disallowed under both Ind AS 2 and AS 2, even though it's used in some other jurisdictions (notably US GAAP). If you're comparing an Indian company's inventory accounting to a US peer, this is a key difference to keep in mind.

Worked Example

A trading company has the following purchase and sale activity for a single product in a month:

Transaction	Units	Cost per Unit	Total
Opening inventory	100	₹200	₹20,000
Purchase (Week 2)	150	₹220	₹33,000
Purchase (Week 4)	100	₹240	₹24,000
Total available	350		₹77,000
Units sold during month	250	—	—
Closing inventory (units)	100	—	—

Under FIFO

	Calculation	Value
COGS (250 units)	100 units @ ₹200 + 150 units @ ₹220	₹20,000 + ₹33,000 = ₹53,000
Closing inventory (100 units)	100 units @ ₹240 (most recent purchase)	₹24,000

Under Weighted Average

	Calculation	Value
Weighted average cost per unit	₹77,000 ÷ 350 units	₹220.00
COGS (250 units)	250 × ₹220.00	₹55,000
Closing inventory (100 units)	100 × ₹220.00	₹22,000

The Impact on Reported Profit

Metric	FIFO	Weighted Average	Difference
Cost of goods sold	₹53,000	₹55,000	₹2,000 lower under FIFO
Closing inventory value	₹24,000	₹22,000	₹2,000 higher under FIFO
Gross profit (if sales = ₹1,00,000)	₹47,000	₹45,000	₹2,000 higher under FIFO

The same purchases, the same sales, the same selling price — but ₹2,000 of difference in reported gross profit purely from the costing method. In prices that rise consistently over time, FIFO will generally show higher profit and higher inventory values than weighted average; in falling-price environments, the relationship reverses.

Consistency Requirement

Ind AS 2 requires the same cost formula to be applied to all inventories having a similar nature and use to the entity. A company can use FIFO for one product category and weighted average for a genuinely different category (e.g., raw materials vs finished goods, if their nature and use differ), but it cannot switch methods opportunistically between periods to manage reported profit — any change in accounting policy must meet the criteria in Ind AS 8 and be disclosed.

Lower of Cost and Net Realisable Value

Whichever costing method is used, the resulting cost figure is only the starting point — Ind AS 2 requires inventory to be carried at the lower of cost and net realisable value (NRV). NRV is the estimated selling price less estimated costs to complete and sell. If a product becomes slow-moving, damaged, or its selling price falls below cost, it must be written down to NRV with the write-down expensed immediately — this is a common audit focus area, especially for inventory nearing year-end.

Why This Matters Beyond the Balance Sheet

Inventory valuation directly affects working capital metrics discussed in the working capital playbook — inventory days, gross margin trends, and the cash conversion cycle are all sensitive to the costing method chosen. It also interacts with balance sheet analysis, since inventory is often one of the largest current asset line items for trading and manufacturing businesses.

Frequently Asked Questions

What inventory valuation methods are permitted under Ind AS 2? ▼

Ind AS 2 (and AS 2) permit FIFO and weighted average cost. LIFO is not permitted, though it is used under some other frameworks like US GAAP. The same cost formula must be applied consistently to inventories of similar nature and use.

How does the choice between FIFO and weighted average affect profit during inflation? ▼

During rising prices, FIFO matches older, cheaper costs against revenue, producing higher gross profit and higher closing inventory value. Weighted average blends old and new costs, giving a smoother result between FIFO and a hypothetical LIFO outcome. Neither method is more "correct" — they reflect different cost flow assumptions.

What is net realisable value and when does it matter for inventory? ▼

Net realisable value (NRV) is the estimated selling price less costs to complete and sell. Ind AS 2 requires inventory to be carried at the lower of cost and NRV — if NRV falls below cost due to damage, obsolescence, or falling prices, the inventory must be written down with the loss recognised immediately.

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