Average Costing is used to track inventory costing via ‘average’ cost, or by averaging the costs of all the quantities that are in stock divided by the total cost of those purchases. The Average Costing Method takes the last purchase of on-hand stock, and any prior purchases, in order until all quantities are accounted for. This ‘average’ cost is then posted when the item is sold. It doesn’t change until a new purchase, at a different cost, is made.
First-In, First-Out (FIFO) is one of the most commonly used methods used to calculate the value of inventory and cost of goods sold (COGS) during an accounting period. The FIFO Method assumes that inventory purchased or manufactured first is sold first and that the newest inventory remains unsold. So the cost of the older inventory is assigned to the cost of goods sold and the cost of the newer inventory is assigned to ending inventory.
Consider this example for an illustration. Let's say you are a furniture store and you purchase 200 chairs for Rs100 and then 300 chairs for Rs200, and at the end of an accounting period you have sold 100 chairs. The weighted average costs, FIFO are as follows :
200 chairs @ Rs100 = Rs20,000
300 chairs @ Rs200 = Rs60,000
Total number of chairs = 500
Cost of a chair: Rs80,000 divided by 500 = Rs160/chair
Cost of Goods Sold: Rs160 x 100 = Rs16,000
Remaining Inventory: Rs160 x 400 = Rs64,000
Cost of Goods Sold: 100 chairs sold x Rs100 = Rs10,000
Remaining Inventory: (100 chairs x Rs100) + (300 chairs x Rs200) = Rs70,000