Inventory Costing Methods

Understanding how inventory costs are calculated is essential for accurate financial reporting and informed business decisions. Different inventory costing methods can significantly impact your cost of goods sold (COGS), gross profit, and taxable income. 

Contents:

• FIFO (First In First Out)
• Weighted Average
• Specific Costing (FIFO Extension for Lot/Serial Control)
• **Costing Example

This article provides an overview of the three inventory costing methods used in Connected: 

1) First-In First-Out (FIFO)

2) Weighted Average

3) Specific Costing (extension of FIFO for Lot/Serial Controlled items only) 

FIFO (First In First Out)

FIFO (First-In, First-Out) is the default inventory costing method in Connected. Under this approach, inventory is costed and depleted in the exact order it was received — meaning the oldest costs are applied first to outgoing items. This method closely mirrors the natural flow of inventory for many businesses, especially those handling perishable or time-sensitive goods.

FIFO provides a more precise view of your current inventory value, since it avoids cost blending and instead reflects actual purchase costs.

Pros

• Aligns with the actual flow of inventory
• Profit and margin calculations reflect true inventory costs

Cons

• Cost of Goods Sold (COGS) may not reflect current replacement costs
• Can overstate profitability during periods of rising prices or volatile markets, when older inventory (lower cost) and newer inventory (higher cost) are both in stock.

Weighted Average

The Weighted Average costing method blends the total cost of inventory with the total quantity available, resulting in a single “Average Cost” that is applied to all units. Rather than tracking the cost of individual items, this method smooths out cost variations by calculating an average every time inventory is received.

This method is best suited for businesses where inventory costs remain relatively stable over time. 

Pros

• Simple to implement and maintain
• Reduces extreme profit or loss swings in financial reports

Cons

• May obscure actual cost trends or changes
• Can be slower to reflect sudden shifts in market pricing
• Can be slower to reflect sudden shifts or volatile exchange rates

Specific Costing (FIFO Extension for Lot/Serial Control)

Specific Costing is used exclusively for inventory items tracked by Lot or Serial numbers, allowing each unit to retain its exact purchase cost. While it follows the same structure as FIFO, it differs by letting specific items (and cost) be chosen for each transaction (Sales/Movement).

This method is ideal for high-value or regulated inventory where precise cost tracking is essential. It provides maximum transparency and control, especially useful when managing returns, warranties, or compliance requirements.

Pros

• Provides highly accurate cost tracking at the unit level
• Enables precise inventory and cost adjustments
• Offers transparency in how and why costs change over time

Cons

• More work to maintain and manage individual item records
• Can be complex to implement due to system and tracking requirements

**Costing Example

The following is a costing example that shows the movement in and out of inventory, using the different costing methods. In each case, the total cost on the invoice is much different, depending on the method used.

Costing Example: