
Stock valuation methods for cost accounting
by Intuit•6• Updated 3 weeks ago
You have two options when working with cost accounting for your stock items:
- First In, First Out (FIFO)
- Moving Average Cost (MAC)
Both have their benefits and help with stock costing in their own way. Review which method will work best for you and your company. Costing methods must be understood and used correctly to make sure you report your money correctly and manage your stock well.
If you're not sure which stock costing method is best for your business, it's always wise to consult with an accountant or financial advisor.
Note:Â Choose your costing method carefully because it can't be changed later.
First In, First Out (FIFO) is a concept used by businesses that track stock. As the name implies, QuickBooks Online will always consider the first units purchased (First In) to be the first units sold (First Out) and will adjust your assets and Cost of Sales (COS) accordingly whenever sales of stock items are entered.
Here are sample scenarios to help you understand the concept of FIFO in QuickBooks Online.
Scenario 1: You purchased 20 widgets for GBP ÂŁ6 apiece. While they remain in stock, the widgets are considered assets and are valued at cost. (Since you haven't sold any widgets yet, your COS for widgets is GBP ÂŁ0.) |
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Scenario 2: Your customers show great interest in widgets, and you realise you don't have enough. You order 30 more widgets, but the price from your wholesaler has gone up to GBP ÂŁ7 apiece since your last purchase. When you record the purchase, QuickBooks Online adds GBP ÂŁ210 to your assets. |
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Scenario 3: A customer purchases 15 widgets. Because the GBP ÂŁ6 units entered your stock before the GBP ÂŁ7 units, QuickBooks Online applies the FIFO rule and values all 15 units in this order at GBP ÂŁ6 apiece. When you record the sale, the asset total for widgets is decreased by GBP ÂŁ90, and the COS for widgets is increased by GBP ÂŁ90. |
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Scenario 4: Another customer purchases 20 widgets. When you record the sale, QuickBooks Online applies the FIFO rule and adds the GBP ÂŁ6 units first. Since you only have five GBP ÂŁ6 units in your stock, the other 15 units for this order are valued at GBP ÂŁ7 apiece. Your widget assets are reduced by GBP ÂŁ135 (5x6 + 15x7), and your COS is increased by GBP ÂŁ135. |
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As you can see, if you then sell more widgets from your current stock to a third customer, they will all be valued at GBP ÂŁ7 apiece. Remember that FIFO has a consequence for reports that can be confusing unless you know to expect it. When you run a transaction report that includes a transaction on which two different rates occurred for the same stock item, that transaction will have separate lines on the report for each COS or asset amount.
For example, if you recorded an invoice for the second customer in the scenario above, the transaction report would show two line items for that invoice: one with a GBP ÂŁ30 change in COS and/or assets, and another with a GBP ÂŁ105 change in COS and/or assets. This is intended behaviour, and the report totals and subtotals will be correct.
Modify the cost and initial quantity of an item
Entering the incorrect cost and initial quantity of the item during the initial set up will result in an incorrect value in the stock asset account. To correct this:
- Go to Settings âš™ and select Products and services.
- Find the item, then select Edit from the Action column.
- Select Starting value.
- Enter the item's correct quantity and cost.
- Select Save.
When you sell products, you must account for the cost of your stock to determine profit. One method for assigning a cost to what you sell (Cost of Sales or COS) and the stock you still have on hand is the Moving Average Cost (MAC) method.
Moving Average Cost method explained
Moving Average Cost, also known as Weighted Average, calculates an average cost for all units of an item in stock. This average updates after every purchase. When units are sold, they are valued at the most recently calculated average cost.
MAC doesn't track costs based on when the item arrived, like FIFO or LIFO. Instead, it uses the same average cost for every unit you have for sale. This balances out the effect of price changes since it doesn’t favour the price of the first or last items you bought.
Calculate stock costs with Moving Average Cost
Moving Average Cost is a way to figure out a new average cost every time you buy something new. Here's how QuickBooks Online calculates MAC:
Formula:
New Moving Average Cost = (Total Cost of Goods Available Before Purchase + Cost of New Purchase) / (Total Units Available Before Purchase + Units in New Purchase)
Let's walk through an example:
Imagine a business sells custom-designed surfboards. Here's a look at your stock activity for the month of January:
Date | Activity | Units | Unit Cost | Total Cost |
Jan 1 | Beginning Stock | 10 | GBP ÂŁ200 | GBP ÂŁ2,000 |
Jan 5 | Purchase | 15 | GBP ÂŁ210 | GBP ÂŁ3,150 |
Jan 12 | Sale | 8 | ? | ? |
Jan 18 | Purchase | 12 | GBP ÂŁ205 | GBP ÂŁ2,460 |
Jan 25 | Sale | 10 | ? | ? |
Let's apply the Moving Average Cost method step-by-step:
1. January 1: Beginning Stock
- Units: 10
- Total Cost: GBP ÂŁ2,000
- Moving Average Cost: GBP ÂŁ2,000 / 10 = GBP ÂŁ200.00
2. January 5: Purchase
- Units Purchased: 15 at GBP ÂŁ210 each = GBP ÂŁ3,150
- Before Purchase: 10 units @ GBP ÂŁ200.00 average cost (GBP ÂŁ2,000 total)
- After Purchase:
- Total Units: 10 + 15 = 25 units
- Total Cost: GBP ÂŁ2,000 (from beginning stock) + GBP ÂŁ3,150 (new purchase) = GBP ÂŁ5,150
- New Moving Average Cost: GBP ÂŁ5,150 / 25 = GBP ÂŁ206.00
3. January 12: Sale
- Units Sold: 8
- Cost of Sales (COS): 8 units * GBP ÂŁ206.00 (current moving average cost) = GBP ÂŁ1,648
- Remaining Stock:
- Units: 25 - 8 = 17 units
- Total Cost: GBP ÂŁ5,150 - GBP ÂŁ1,648 = GBP ÂŁ3,502
- Moving Average Cost (remains the same until next purchase): GBP ÂŁ3,502 / 17 = GBP ÂŁ206.00
4. January 18: Purchase
- Units Purchased: 12 at GBP ÂŁ205 each = GBP ÂŁ2,460
- Before Purchase: 17 units @ GBP ÂŁ206.00 average cost (GBP ÂŁ3,502 total)
- After Purchase:
- Total Units: 17 + 12 = 29 units
- Total Cost: GBP ÂŁ3,502 (from remaining stock) + GBP ÂŁ2,460 (new purchase) = GBP ÂŁ5,962
- New Moving Average Cost: GBP ÂŁ5,962 / 29 = GBP ÂŁ205.59 (rounded to two decimal places)
5. January 25: Sale
- Units Sold: 10
- Cost of Sales (COS): 10 units * GBP ÂŁ205.59 (current moving average cost) = GBP ÂŁ2,055.90
- Remaining Stock:
- Units: 29 - 10 = 19 units
- Total Cost: GBP ÂŁ5,962 - GBP ÂŁ2,055.90 = GBP ÂŁ3,906.10
- Moving Average Cost (remains the same until next purchase): GBP ÂŁ3,906.10 / 19 = GBP ÂŁ205.58 (slight difference due to rounding)
Summary for January:
- Total Cost of Goods Sold: GBP ÂŁ1,648 (Jan 12 sale) + GBP ÂŁ2,055.90 (Jan 25 sale) = GBP ÂŁ3,703.90
- Ending Stock Value: 19 units at an average cost of GBP ÂŁ205.59 = GBP ÂŁ3,906.21 (slight difference due to rounding from GBP ÂŁ3906.10 and the GBP ÂŁ205.59 average cost)
Moving Average Cost is a good choice for businesses that:
- Sell homogenous, undifferentiated products: If your stock items are essentially identical, like sand, grains, liquids, or mass-produced goods where individual units aren't unique, MAC makes sense because it treats all units equally.
- Experience fluctuating purchase prices: MAC gives you a stable COS and stock valuation. This helps you avoid the ups and downs of purchase costs that you see with FIFO or LIFO.
- Don't need to track the exact flow of specific stock items: If knowing which specific unit was purchased first or last isn't crucial for your operations or compliance, MAC simplifies stock tracking.
- Prefer a middle-ground approach for financial reporting: MAC can give you COS and stock values between FIFO and LIFO in periods of rising prices. It offers a more balanced financial view.
- Utilise a perpetual stock system: Moving Average Cost works best for perpetual stock systems, where stock records update after each transaction. The average cost is figured out again with each new purchase.