First-in First-Out Inventory Method

The first-in first-out method of valuing inventory, or FIFO, bases its cost of goods sold on raw materials
purchased at the beginning of a given accounting period. Conversely, this method bases the value of
inventory on the cost of raw materials purchased later in the given accounting period. According to New
York University's Stern School of Business, using the first-in first-out method leads to an inventory
valuation closer to current replacement costs. When inflation occurs, this method generates low
estimates for cost of goods sold and high net income. This can lead to higher tax liability for a business,
because the company is bringing in more income with reduced costs.

Last-In First-Out Method

The last-in first-out method of valuing inventory, or LIFO, bases a company's cost of goods sold on
materials purchased at the end of a given accounting period. This method values inventory based on the
value of materials purchased at the beginning a given accounting period. The last-in first-out method
generates the highest cost of goods sold and the lowest net income of acceptable inventory valuation
methods. Additionally, LIFO doesn't generate a clear picture of ending inventory value because the
method bases its findings on older inventory. This stock could be obsolete and have little value to
consumers. Over time, this can lead to distorted inventory values as older inventory continues to waste
away in company warehouses or retail shelves.

Weighted Average Inventory

The weighted average method of determining inventory value uses the average cost of all products sold during
a given accounting period. This figure determines the value of both inventory and the cost of goods sold.
Problems can arise when using this method if inaccuracies in tabulating inventory levels at the end of an
accounting period occur. For example, if a business doesn't accurately account for lost/stolen inventory, it can
create false sales figures that can create misleading earnings reports. Combing through financial records and
sales reports may be necessary to correct these problems.

Perpetual and Periodic Inventory Systems

A business can use either of two inventory recording methods and remain compliant with the generally
accepted accounting principles, or GAAP, as monitored by the U.S. Financial Accounting Standards Board.
The perpetual inventory system updates inventory accounts every time a customer purchases company
products. While this helps a business maintain accurate inventory ledgers, it can also create problems if the
company uses an automated system to manage real-time inventory levels. Errors in inventory software can
have both accountants and information technology professionals pouring over data to correct false inventory
records. Conversely, the periodic inventory system only accounts for inventory levels at the end of given
accounting periods. This leaves room for inventory errors to occur throughout given accounting periods
because the business only checks for errors when period end.