How to Calculate Closing Stock: FIFO, LIFO & Average Cost
Accurately value your ending inventory to ensure precise financial reporting and gain clear business insights.
Closing stock is the value of goods a business has on hand at the end of an accounting period. It includes raw materials, work-in-progress, and finished goods. Accurate determination of closing stock is fundamental for financial accounting in product-selling enterprises. It indicates unsold goods and impacts financial performance. Proper valuation is important for internal management and external reporting.
Understanding Closing Stock
Closing stock measures merchandise or materials remaining unsold at the end of an accounting cycle. This amount is a current asset on a company’s balance sheet, expected to convert to cash within one year. Its valuation directly impacts reported financial outcomes.
The value of closing stock is inversely related to Cost of Goods Sold (COGS), direct costs of goods sold. Higher closing stock leads to lower COGS. Conversely, lower closing stock results in higher COGS. This relationship directly influences gross profit, derived from net sales minus COGS.
Accurate closing stock valuation directly shapes reported profitability. It also impacts income tax, as COGS reduces taxable income. Businesses must value inventory at the lower of cost or current market value for tax purposes, preventing overstatement. Precision in this valuation is important for a true and fair view of financial position and performance.
Inventory Costing Methods
Businesses utilize various inventory costing methods to value closing stock and sold goods. Methods are based on different assumptions about inventory flow, even if physical movement differs. Method choice can alter reported financial figures and tax liabilities. The Internal Revenue Service (IRS) requires businesses to apply their chosen method consistently, and any change requires IRS approval.
The First-In, First-Out (FIFO) method assumes the first units of inventory purchased or produced are the first ones sold. This aligns with the natural flow of many businesses, especially for perishable goods. Under FIFO, inventory remaining at the period’s end consists of most recently acquired goods, reflecting current market costs on the balance sheet. During periods of rising prices, FIFO results in a lower Cost of Goods Sold and higher reported taxable income.
Conversely, the Last-In, First-Out (LIFO) method assumes the last units of inventory purchased or produced are the first ones sold. Inventory on hand is from earliest purchases. While LIFO may not always mirror the physical flow of goods, it is used by companies in times of rising costs to report higher Cost of Goods Sold and lower taxable income. LIFO is accepted under U.S. Generally Accepted Accounting Principles (GAAP) but is not permitted under International Financial Reporting Standards (IFRS).
The Weighted Average Cost method calculates the average cost of all available units for sale during a period. This average cost applies to units sold and remaining closing stock. This method smooths out price fluctuations, as it does not prioritize any specific purchase order. It is favored for homogenous products where individual unit costs are difficult to track. This approach provides a valuation blending all purchase costs.
Applying Inventory Costing Methods
Calculating closing stock involves applying the chosen inventory costing method to the physical count of remaining units at period end. Consider a hypothetical business with beginning inventory of 100 units at $10 each. It made two purchases: 150 units at $12 each and 200 units at $13 each. If 300 units were sold, closing stock calculation varies by method.
First-In, First-Out (FIFO) Calculation
Under the FIFO method, cost for the 300 units sold comes from earliest inventory. The first 100 units sold are costed at $10 each, totaling $1,000. The next 150 units sold come from the first purchase of 150 units at $12 each, totaling $1,800. The remaining 50 units sold (300 – 100 – 150) are taken from the second purchase of 200 units at $13 each, amounting to $650.
Total Cost of Goods Sold using FIFO is $1,000 + $1,800 + $650 = $3,450. Total units available for sale were 450 (100 beginning + 150 + 200 purchased). After selling 300 units, 150 units remain in closing stock. These remaining 150 units are from the most recent purchases, specifically the 150 units from the 200 purchased at $13 each. Therefore, closing stock under FIFO is 150 units $13 = $1,950.
Last-In, First-Out (LIFO) Calculation
For the LIFO method, cost for the 300 units sold is assigned from most recent inventory. The first 200 units sold are from the last purchase at $13 each, totaling $2,600. The remaining 100 units sold (300 – 200) come from the second-to-last purchase of 150 units at $12 each, totaling $1,200.
Total Cost of Goods Sold using LIFO is $2,600 + $1,200 = $3,800. With 150 units remaining in closing stock, these units are from the earliest inventory. This includes the initial 100 units from beginning inventory at $10 each, totaling $1,000. The remaining 50 units (150 – 100) are from the first purchase of 150 units at $12 each. Therefore, closing stock under LIFO is (100 units $10) + (50 units $12) = $1,000 + $600 = $1,600.
Weighted Average Cost Calculation
The Weighted Average Cost method calculates the average cost of all units available for sale. Total cost of all units available is (100 units $10) + (150 units $12) + (200 units $13) = $1,000 + $1,800 + $2,600 = $5,400. Total units available for sale were 100 + 150 + 200 = 450 units.
The weighted average cost per unit is calculated as total cost of units available divided by total units available: $5,400 / 450 units = $12 per unit. With 150 units remaining in closing stock, the closing stock value under the Weighted Average Cost method is 150 units $12 = $1,800. This method provides a middle ground between FIFO and LIFO, reflecting an averaged cost for all inventory.
