Inventory Valuation Under IFRS: FIFO vs Weighted Average

What Is Inventory Valuation and Why It Matters

Every business that holds inventory faces the same puzzle. You bought the same product at different prices throughout the year, and now you need to answer two questions that hit your financial statements directly. What was the cost of the units you sold? And what is the cost of the units still sitting in the warehouse?

The inventory valuation methods IFRS permits (under IAS 2) give you two acceptable answers — and the one you pick moves real money on paper.

Imagine a Riyadh electronics distributor. In early January they buy 50 laptops at SAR 2,400 each. Two weeks later, prices rise and they buy 80 more at SAR 2,500. At the end of the month, another batch of 60 comes in at SAR 2,600. Then they sell 120 laptops to a corporate client. Which cost do you assign to those 120 units?

There is no physical answer — the laptops look identical on the warehouse floor. Accounting has to assume a flow. Under IAS 2, the two assumptions you can use are FIFO (first-in, first-out) and weighted average cost. Pick one, and cost of goods sold, gross profit, ending inventory, and even zakat all shift.

This article walks you through how both methods work, the practical differences between them, and the mistakes that trip up junior accountants — especially in Saudi Arabia where many companies move between IFRS and legacy systems.

The Three Methods — FIFO, Weighted Average, and Why IAS 2 Bans LIFO

Three cost-flow assumptions exist in the accounting world:

• FIFO (First-In, First-Out): assumes the earliest units purchased are sold first. Remaining inventory is valued at the most recent costs.
• Weighted Average Cost: blends all units into one average cost, recalculated after each purchase (perpetual method) or at period-end (periodic method).
• LIFO (Last-In, First-Out): assumes the most recent units are sold first. Prohibited under IFRS.

Why does IAS 2 prohibit LIFO? Two reasons.

First, LIFO does not reflect the actual physical flow of most inventory. Real warehouses move the oldest stock out first to prevent spoilage and obsolescence — FIFO matches that reality.

Second, LIFO is vulnerable to manipulation. A company can pump up cost of goods sold (and reduce taxable income) simply by buying at year-end in an inflationary market. Tax authorities in jurisdictions that permit LIFO (like the US under GAAP) add complex rules to contain this. The IASB sidestepped the problem by banning the method outright.

For IFRS-reporting entities in Saudi Arabia — every Tadawul-listed company and most privately held firms that have adopted SOCPA standards — only FIFO and weighted average are on the table. If you trained on US GAAP or worked under an American parent, unlearn LIFO for your local books.

One more rule from IAS 2: you must apply the same cost formula to inventories with similar nature and use. You cannot use FIFO for your Samsung inventory and weighted average for your Apple inventory — both are consumer electronics with similar use patterns. But you can use FIFO for raw materials and weighted average for finished goods if they serve different operational purposes.

FIFO Worked Example — A Riyadh Electronics Distributor

Let's walk through FIFO with specific numbers. Al-Noor Electronics, a hypothetical Riyadh-based B2B distributor, had these January transactions for a single laptop model:

Total units available: 190. Sold: 120. Ending inventory: 70 units.

FIFO says the 120 sold come from the oldest layers first:

• All 50 from opening inventory: 50 × SAR 2,400 = SAR 120,000
• 70 more units from Purchase 1: 70 × SAR 2,500 = SAR 175,000
• Cost of goods sold = SAR 295,000

Ending inventory under FIFO:

• 10 units remaining from Purchase 1: 10 × SAR 2,500 = SAR 25,000
• All 60 units from Purchase 2: 60 × SAR 2,600 = SAR 156,000
• Ending inventory = SAR 181,000

If Al-Noor sold the 120 laptops at SAR 3,200 per unit (revenue = SAR 384,000), gross profit is:

SAR 384,000 − SAR 295,000 = SAR 89,000

Notice that under FIFO in a rising-price environment, cost of goods sold reflects older, cheaper costs and ending inventory reflects newer, more expensive costs. This tends to produce a higher reported profit — a useful framing when reading financial statements of companies in high-inflation periods.

Weighted Average Worked Example — Same Numbers, Different Answer

Now run the same transactions through the weighted average cost formula under the periodic method.

Total cost of units available = SAR 120,000 + SAR 200,000 + SAR 156,000 = SAR 476,000

Total units available = 190

Weighted average cost per unit = SAR 476,000 ÷ 190 = SAR 2,505.26

Gross profit under weighted average:

SAR 384,000 − SAR 300,632 = SAR 83,368

Side-by-side comparison:

In rising-price environments, FIFO always produces lower COGS and higher profit than weighted average. The difference here is small (SAR 5,632 on a SAR 384,000 sale — about 1.5%), but it scales quickly with price volatility and inventory turnover.

Under the perpetual weighted average (sometimes called moving average), the average is recalculated after every single purchase, not at period-end. The calculation is more work, but it gives real-time inventory values — important for companies on ERP systems closing monthly or quarterly.

Choosing Between FIFO and Weighted Average

There is no universally right choice. IAS 2 lets management select the method that best reflects how inventory flows through the business. In practice, the decision comes down to three factors.

Pick FIFO when:

• Inventory has a natural sequence (food, pharmaceuticals, fashion) — FIFO matches physical flow
• You want ending inventory on the balance sheet to approximate replacement cost
• You operate in Saudi Arabia and want financial statements comparable to IFRS peers — most Tadawul-listed industrial companies use FIFO

Pick weighted average when:

• Inventory is interchangeable and indistinguishable (oil, grain, chemicals, bulk commodities)
• You want to smooth the impact of price volatility on cost of goods sold — useful in volatile raw materials markets
• Your accounting system does not track cost layers well (common in smaller businesses on basic ERP or spreadsheet-based inventory)

One rule you cannot break: once you pick a method, you are locked in for similar items. Changing the cost formula is an accounting policy change under IAS 8 — it requires retrospective restatement of prior periods and disclosure of why the change was made. Auditors scrutinize this carefully, because it is a classic red flag for earnings management.

A 2021 study of 35 Saudi manufacturing companies found that firms using weighted average reported higher profits in that specific sample period — the opposite of what theory predicts, because prices in that sample were trending downward for some commodities. The reminder: FIFO versus weighted average effects depend on the direction of price movements, not on a fixed rule.

Common Mistakes in Inventory Valuation

Five mistakes we see repeatedly when reviewing student and junior-accountant work.

1. Using LIFO in IFRS books. If your company converted from US GAAP, or you are preparing reports for a US parent, do not carry LIFO over. Your statutory Saudi books must use FIFO or weighted average — full stop.

2. Mixing cost formulas for similar inventory. Using FIFO for one laptop brand and weighted average for another violates the IAS 2 consistency requirement. If items are similar in nature and use, they must share a method.

3. Including non-inventoriable costs. IAS 2 limits inventory cost to purchase price, import duties, freight-in, and costs needed to bring inventory to its present location and condition. Do not include abnormal waste, storage costs after production, selling expenses, or administrative overheads. A common error is capitalizing all warehouse rent — only storage that is a necessary part of the production process qualifies.

4. Ignoring net realizable value. Cost is not always the right measurement. If market prices have dropped or the inventory has become obsolete, you must write it down to net realizable value (covered in the next section). Skipping this step overstates both assets and profit.

5. Forgetting to adjust for purchase returns and trade discounts. Trade discounts reduce cost at the time of purchase. Cash discounts (like 2/10 net 30) are usually recorded as finance income when taken. Mixing these two up inflates both inventory and cost of goods sold.

Net Realizable Value and IAS 2 Write-Downs

Inventory is measured at the lower of cost and net realizable value (NRV) under IAS 2 paragraph 9. This is a critical step often skipped in junior-level bookkeeping.

NRV definition (IAS 2.6): the estimated selling price in the ordinary course of business, less the estimated costs to complete and sell.

Worked example. Al-Noor Electronics holds 30 older-model smartphones in inventory at a total cost of SAR 100,000. The phones can now only be sold at SAR 85,000 in aggregate, and shipping and marketing costs to move them will be SAR 3,000.

NRV = SAR 85,000 − SAR 3,000 = SAR 82,000

Because NRV (SAR 82,000) is below cost (SAR 100,000), Al-Noor must write the inventory down:

The write-down hits profit or loss immediately — there is no deferring it to the period of actual sale.

If NRV recovers in a later period (prices rebound, obsolescence reverses), IAS 2 allows reversal of the previous write-down, up to the original cost. This is a key IFRS difference from US GAAP, where inventory write-downs are generally permanent.

NRV assessment happens at every reporting date, not only annually. For companies with volatile inventory — technology, fashion, pharmaceuticals near expiry — monthly NRV reviews are standard practice.

Practice Inventory Valuation on Accountery

Theory clicks faster when you do the math on realistic scenarios. Accountery's practice library covers:

• FIFO vs weighted average calculations — compute COGS and ending inventory side by side on the same dataset
• NRV write-downs — identify items below cost and record the adjustment
• Purchase returns and trade discounts — calculate net inventory cost correctly
• Year-end inventory count reconciliation — identify the causes of physical-versus-perpetual differences
• IAS 2 case studies with SAR amounts — synthesize recognition, measurement, and disclosure decisions

Each exercise gives instant feedback, and your mistakes point directly to the IAS 2 concept that needs review. For SOCPA, ACCA, and CMA candidates, this is the fastest way to build the speed and accuracy the exams demand.