FIFO/LIFO and Moving Average calculation difference
The price at which the product is valued in ERPNext is based on the total cost incurred to get it on sales. It can consist of both direct and indirect costs such as freight, labor, duties, taxes, handling charges and raw material cost.
In ERPNext, depending upon the Valuation Method chosen to the Item or specified under Stock Settings, the calculation method of this Valuation Rate may vary.
The following methods are available:
- FIFO (First-In-First-Out)
- LIFO (Last-In-First-Out)
- Moving Average
The selected method has a direct influence on how stock is being consumed and valued at the moment of a sale or issue.
Calculating Valuation Rate at the Time of Sale
According to FIFO (First-In-First-Out):
In FIFO, inventory is released in the order it arrives. The oldest inventory that is on hand is used up first.
Example:
- Transaction 1: 10 @ 100
- Transaction 2: 10 @ 120
Putting up a sales of 15 qty:
- This will result in 10 qty of Transaction 1 being used (10 x 100= 1000)
- 5 qty will be consumed out of the Transaction 2 (5 qty x 120 = 600)
The cost of 15 qty issued = 1600 Remain stock = 5 qty x 120 = 600
This maintains the inventory cost current at all times with the recent purchases and busts older stock values out first.
According to LIFO (Last-In-First-Out):
In LIFO, stock is issued from the most recent purchase first. The most recent stock is used up first before earlier stock.
Example:
- Transaction 1: 10 units @ 100 each
- Transaction 2: 10 @ 120 each
If 15 qty are sold:
- 10 qty will be drawn from Transaction 2 (10 × 120 = 1200)
- 5 qty will be drawn from Transaction 1 (5 × 100 = 500)
Total cost of 15 qty issued = 1700 Remaining stock = 5 qty @ 100 = 500
This approach indicates recent costs in the valuation of sales but excludes costs of earlier stocks still in inventory.
As indicated by Moving Average:
With the Moving Average method, stock price is revalued each time additional stocks are bought. The system calculates the average cost weighted by dividing the sum total of the items in stock to the sum total quantity.
Example:
- Transaction 1: 10 units @ 100 each = 1000
- Transaction 2: 10 units @ 120 each = 1200
- Total = 2200 for 20 units
Average Valuation Rate = 2200 ÷ 20 = 110
If a sale of 15 qty is done:
- 15 × 110 = 1650
Stock remaining = 5 qty × 110 = 550
This approach smooths price variance, because the valuation rate is continuously recalculated, which is beneficial in the case of highly variable purchase prices.