Under Average cost method, an average cost is calculated for all units, and this average cost is assigned to all the units remaining in ending inventory and cost of sales for units sold. 'To determine average cost, divide the total number of units available for sale into the total purchase cost for the period of time under examination.'(James o Gill, Moria Chatton, page 46)2 For a company using periodic inventory system, the method is referred to weighted average; and where a perpetual inventory system is in use, this method is called moving average method. As costs are averaged out before applying to ending inventory, the material costs under inflation is not very near to market prices but a lower than that because of the effect of earlier purchases in averaging out.
LIFO means last in first out and under this method the prices at which merchandise was most recently purchased are used to determine the amounts charged to cost of goods sold. LIFO assumes that 'goods are all the same and interchangeable.'(Peter J Eisen, page 322)3 Ending inventory is valued using the prices associated with the units acquired the earliest. As a result, cost of goods sold computed under LIFO most closely approximate current cost. During inflation LIFO will result in lowest value for ending inventory and highest amount of goods sold and the lowest amount gross profits and net income.
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