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.
An example will make this clearer.
Let’s consider a retailer that sells computer components. They purchase the computer components from several suppliers: