10 min read

Inventory Valuation Methods in India: FIFO or Weighted Average

Inventory valuation methods in India come down to first in, first out (FIFO) or weighted average cost, with specific identification for unique items. Last in, first out is not permitted.

By Praveen Nune, Co-Founder & CEO · Updated 30 Oct 2026

A shopkeeper in an Indian stockroom checks rows of identical cartons on shelves with a clipboard.

Key takeaways

Value inventory with FIFO or weighted average cost, and use specific identification for items that are not interchangeable. LIFO is not an allowed cost formula in the accounting or tax standards.
In our worked example below, prices rise 22.5% and FIFO shows closing inventory of ₹35,500 against ₹33,250 under weighted average. That is a gap of ₹2,250 on ₹66,500 of purchases, or 3.4%.
Company accounts and income tax both value inventory at the lower of cost and net realisable value (NRV): the selling price less the costs to complete and sell. Tax applies NRV item by item.
Choose a method once and keep it. Change it only with a documented cause. Test your inventory records before trusting any method's output.

In this article

1Which inventory valuation methods can an Indian business use?
2What do the accounting and tax rules require beyond choosing a formula?
3How much do FIFO and weighted average change profit? A worked example
4What goes wrong when you choose or switch an inventory costing method?
5How do you change an inventory valuation method safely?
6Can your inventory records support the method you choose?
7Frequently asked questions

Accounting software can offer a costing method that Indian standards do not accept. TallyPrime, for one, lists last in, first out (LIFO) in two forms beside first in, first out (FIFO) and average cost, so a method in a drop-down is no proof that you may use it.

The same ₹66,500 of purchases gives closing inventory of ₹35,500 under FIFO and ₹33,250 under weighted average cost (total cost of units on hand divided by total units) in the worked example below, and tax follows. Both are accepted for company accounts and for income tax. They put the same total cost through the books in a different order, so profit, closing inventory and tax move in the year you choose or switch.

This page sets out the rules, runs one set of purchases through each method with the arithmetic shown, and ends with tests for the inventory records any method depends on. It is written for finance heads, owners and operations leads at manufacturing and trading businesses. The decision table comes first.

Which inventory valuation methods can an Indian business use?

Indian standards allow three ways to assign cost to inventory: specific identification, FIFO and weighted average cost. Specific identification suits items that are not interchangeable, such as a made-to-order machine. FIFO and weighted average suit the rest. LIFO, last purchase cost and zero cost are not cost formulas in the standards.

A technician tags a one-off machine on a workshop bench, separate from a shelf of identical boxed parts. — A made-to-order machine is tracked item by item, while interchangeable goods share a cost formula.

Method	Company accounts	Income tax computation	Best fit (our recommendation)	Records you must keep
Specific identification	Allowed for non-interchangeable items and project-specific goods	Same	Made-to-order, serial-numbered or high-value units	Actual cost against each unit or lot
FIFO	Allowed	Allowed	Goods that expire or are issued oldest first	Each receipt as a cost layer with date, quantity and unit cost
Weighted average (periodic or moving)	Allowed	Allowed	Interchangeable goods bought repeatedly, such as raw materials and packaging	Running quantity and total value per item
LIFO, last purchase cost, zero cost	Not a listed cost formula	Not a listed cost formula	Do not use	Not applicable

Two terms in the table need definitions. Periodic weighted average computes one rate for the whole period. Moving weighted average recalculates the rate after every receipt. The method pages cover each in depth: FIFO inventory method and weighted average cost method.

What do the accounting and tax rules require beyond choosing a formula?

Inventory is valued at the lower of cost and NRV under both the accounting standards and the tax standard. The formula choice is only the first step. The rules also fix what counts as cost, how write-downs work and when a method may change.

Accounting rules. Accounting Standard (AS) 2 says inventories are valued at the lower of cost and NRV (paragraph 5). Its cost formulas are specific identification, FIFO and weighted average (paragraphs 14 to 17). International Accounting Standard (IAS) 2 permits the same two formulas for interchangeable items. Companies reporting under Indian Accounting Standards (Ind AS) apply Ind AS 2, which also excludes LIFO.

Tax rules. The Income Computation and Disclosure Standard (ICDS) II was notified as Notification 87/2016 on 29 September 2016. It assigns cost by FIFO or weighted average, with specific identification for non-interchangeable goods. It also says:

Write-downs to NRV are made item by item (paragraph 19).
Standard cost is accepted where it approximates actual cost (paragraph 18).
A method once adopted "shall not be changed without reasonable cause" (paragraph 23).

As of October 2026, the Income-tax Act, 2025 applies from 1 April 2026. Section 277 values inventory at the lower of actual cost or NRV, computed under the ICDS notified under section 276(2). As of October 2026, ICDS II applies for tax year 2026-27. Budget 2026-27 announced that ICDS will be repealed from 1 April 2027 (tax year 2027-28), with their requirements to be incorporated into Ind AS (topic-wise summary). Check the final notification before planning a method change.

Where book and tax differ (Ind AS 2 versus ICDS II comparison):

ICDS II includes duties and taxes in purchase cost whether or not they are recoverable. Ind AS 2 leaves recoverable taxes out.
Ind AS 2 reverses a write-down when value recovers. For tax, a recovery appears as a higher valuation in later periods.
The ICDS II wording names excise, value added tax (VAT) and customs duty. Confirm with your tax adviser how Goods and Services Tax (GST) input credit sits in your tax cost.

How much do FIFO and weighted average change profit? A worked example

On one set of purchases with rising prices, FIFO gives closing inventory of ₹35,500 and weighted average gives ₹33,250. Weighted average therefore reports ₹2,250 more cost of goods sold (COGS, the cost of units sold) and ₹2,250 less profit. This is our model, built for this page, not an official figure.

Inputs. Three purchases: 100 units at ₹200 on 1 April, 100 at ₹220 on 1 May and 100 at ₹245 on 1 June. That is 300 units costing ₹66,500. The price rises 22.5% from ₹200 to ₹245. We sell 150 units after the June receipt.

Formulas. COGS is the cost of the 150 units sold. Closing inventory is ₹66,500 less COGS.

Method	COGS	Closing inventory (150 units)
FIFO	₹31,000	₹35,500
Weighted average	₹33,250	₹33,250
LIFO (not permitted, shown for comparison)	₹35,500	₹31,000

Working:

FIFO COGS = 100 × ₹200 + 50 × ₹220 = ₹31,000. Closing inventory = 50 × ₹220 + 100 × ₹245 = ₹35,500.
Weighted average rate = ₹66,500 ÷ 300 = ₹221.67. COGS = 150 × ₹221.67 = ₹33,250.
The FIFO versus weighted average gap is ₹2,250, which is 3.4% of ₹66,500 purchases (2,250 ÷ 66,500).

Timing changes the answer. Suppose the 150 units sell after the May receipt and the June inventory arrives later:

FIFO is unchanged: COGS ₹31,000 and closing inventory ₹35,500.
Moving average: the rate after May is (₹20,000 + ₹22,000) ÷ 200 = ₹210. COGS is 150 × ₹210 = ₹31,500. The remaining 50 units are worth ₹10,500, and June adds ₹24,500. Closing inventory is ₹35,000, a new rate of ₹233.33 on 150 units.
Periodic weighted average ignores timing and still gives ₹33,250.

The method gap is timing, not total cost. If all 300 units sold, every method would charge ₹66,500.

NRV can erase the gap. Take selling price less selling cost of ₹200 a unit. Weighted average closing inventory of ₹33,250 against NRV of 150 × ₹200 = ₹30,000 means a write-down of ₹3,250. FIFO's ₹35,500 means ₹5,500. Both methods then carry the inventory at ₹30,000. For tax, run this test item by item, never on the total.

What goes wrong when you choose or switch an inventory costing method?

The costliest mistakes are trusting the software menu, choosing for profit and valuing in bulk. Each one comes from treating the method as a setting when it is an accounting policy.

Using whatever the software lists. TallyPrime's costing methods include LIFO Annual, LIFO Perpetual, Last Purchase Cost and At Zero Cost. None of these is a cost formula in AS 2, IAS 2 or ICDS II. Check the menu against the standards, and set non-compliant methods off for statutory books.
Switching to move profit. In rising prices, a change from FIFO to weighted average usually lowers closing inventory and profit. That makes the switch look attractive for tax, but a change made only to move profit has no reasonable cause under ICDS II.
Comparing totals. ICDS II requires NRV write-downs item by item, so a profitable item cannot hide a loss-making one.
Choosing by habit. Our recommendation: use weighted average for interchangeable goods bought in bulk, because one running rate per item is easy to keep and defend. Use FIFO where batches expire or must go out oldest first, so the costing matches the physical flow. Neither choice is a lasting tax saving, because the gap reverses when prices fall.

How do you change an inventory valuation method safely?

A change is allowed only with a documented reason and a measured effect. For Ind AS reporters it is an accounting policy change under Ind AS 8 and applies retrospectively. Run these five checks before you switch.

1
Reason test
Write one sentence explaining why the new method gives more reliable and relevant information. Pass: the sentence refers to your inventory flow or records. Fail: the reason is lower tax or higher profit.
2
Restatement test
Recompute the prior year's closing inventory under the new method. Pass: both years sit side by side. Fail: only the current year is recalculated. A policy change is applied retrospectively, meaning to prior periods' comparative figures, unless that is impracticable.
3
Tax cause test
Record the "reasonable cause" required by ICDS II paragraph 23 in your tax file, and check the final notification, because ICDS is announced for repeal from 1 April 2027. Pass: dated and approved by management. Fail: no document.
4
Disclosure test
Disclose the policy change in the accounts and in the tax audit report (Form 3CD under the 1961 Act, or its equivalent under the Income-tax Rules, 2026). Check the current form and clause numbers with your auditor. Pass: the change appears in both. Fail: either omits it.
5
Direction check
In rising prices, FIFO to weighted average lowers profit. In falling prices the effect reverses, and this follows from the arithmetic above. Pass: the sign of your restated figure matches the price trend. Fail: it does not, so recheck the inputs.

Can your inventory records support the method you choose?

Yes, if five tests pass: quantity, FIFO layers, weighted average rate, landed cost and year-end cut-off. Each test below states what counts as a pass. Valuation is only as accurate as the receipts, rates and quantities beneath it. Run these five tests on a sample of five items before year-end.

Two warehouse staff count cartons on a shelf and compare them with paper receipts and a laptop. — Counted stock, receipts and system records must agree before any costing method can be trusted.

1
Quantity test
Count five items and compare them with system on-hand. Pass: all five match to the unit. Fail: any mismatch, because valuation will inherit the error. Perpetual inventory system explains how to fix and test continuous records.
2
Layer test (FIFO)
List open receipts for each item with quantity and unit cost. Pass: layer quantities add up to on-hand quantity. Fail: they do not.
3
Rate test (weighted average)
Recompute one item's rate by hand: total cost ÷ total units. Pass: it matches the system rate to the paisa (one hundredth of a rupee). Fail: any difference.
4
Landed cost test
Take one import or freight-heavy purchase and check that freight, duty and handling sit in unit cost. Pass: unit cost equals invoice price plus allocated charges. Fail: they sit in an expense account. The landed cost calculation guide shows the formula.
5
Cut-off test
List receipts and invoices dated in the last three days of the year. Pass: each sits in the period of physical receipt. Fail: any receipt is booked in the next period.

We built Arka Inventory so these inputs stay on record. It supports FIFO picking, and lot, batch and expiry tracking, so the oldest batch leaves first. It integrates with Tally and QuickBooks Online, and it tracks purchase orders and warehouse transfers across multiple warehouses. Landed cost, which spreads shipping, duties, taxes and fees across items for the landed cost test, and lot and serial tracking are on our Enterprise plan, which has custom pricing (as of October 2026). A 15-day free trial with full access and no credit card is available, and setup typically takes at least two weeks, depending on data readiness. To see it on your own inventory data, contact our sales team.

See your inventory records ready for any costing method

Arka Inventory keeps FIFO picking, lot, batch and expiry tracking and landed cost on record, and you can see it on your own inventory data.

Contact our sales team

Frequently asked questions

No. AS 2, IAS 2 and ICDS II list specific identification, FIFO and weighted average as cost formulas, and LIFO is not among them. Some software still offers LIFO, but that does not make it valid for statutory accounts or tax.

Neither is better in general. Weighted average is usually easier to keep and defend for interchangeable goods bought repeatedly. FIFO suits goods that expire or are issued oldest first. Both are accepted for accounts and tax, so choose on your records.

Yes, with a documented cause. ICDS II says a method once adopted shall not change without reasonable cause. Under Ind AS 8, the change must give relevant and reliable information and is applied retrospectively unless that is impracticable.

It means you carry inventory at the lower of what it cost and what it can be sold for after completion and selling costs. AS 2 sets the principle, and ICDS II applies the write-down item by item for tax.

From 1 April 2026, section 277 values inventory at the lower of actual cost or NRV under the ICDS notified under section 276(2). ICDS II applies for tax year 2026-27, but Budget 2026-27 announced that ICDS will be repealed from 1 April 2027, so check the final notification before planning a method change.

Sources

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