Inventory Costing: FIFO vs Weighted Average

Trading and manufacturing businesses live or die by inventory accounting. The cost flow assumption you choose, FIFO or Weighted Average, changes both your reported margins and your tax bill. The choice is largely permanent.

What the two methods do

FIFO (First-In, First-Out): assumes the oldest inventory is sold first. Cost of goods sold uses the oldest costs; ending inventory carries the newest costs. In rising-cost environments, FIFO produces higher reported profit and higher inventory values.

Weighted Average: pools all inventory and uses an average cost. Each unit of cost of goods sold uses the same blended cost. Ending inventory and COGS sit between FIFO and LIFO outcomes. Smoother reporting; less precise per-batch tracking.

Which is better for UAE businesses

Weighted Average is the most common choice for UAE SMEs because it is administratively simpler. Most accounting systems handle it natively. It is appropriate when products are interchangeable (most commodity-like SKUs).

FIFO is better when batches matter, perishables, fashion (where seasonal pricing matters), high-value items where you want to track exact unit cost. FIFO requires good batch tracking; if you cannot track batches, FIFO becomes a fiction.

Cost components

Inventory cost includes: purchase price, import duties, non-recoverable VAT, transport-in, storage during transit, and any other costs of bringing the inventory to its current location and condition. Excluded: storage of finished goods, selling costs, distribution costs.

Finished-goods inventory in manufacturing must include direct materials, direct labour, and a share of production overhead. Variable production overhead is allocated based on actual production; fixed production overhead is allocated based on normal capacity. Document the allocation methodology.

Net Realisable Value and write-downs

Inventory is carried at the lower of cost and Net Realisable Value (NRV), selling price less costs to complete and sell. If NRV drops below cost (damaged stock, slow-mover, obsolescence), write down to NRV through a charge to P&L.

Run an NRV review at least annually, more often for fashion or technology where obsolescence cycles are short. Document the review and any adjustments. Auditors will test inventory valuation, particularly for material items.

This guide is general information, not professional advice. For situations that involve specific facts, talk to your accountant, or hire one of ours from the marketplace.