Under FIFO, the cost of goods sold is based upon the cost of material bought earliest in the period, while the cost of inventory is based upon the cost of material bought later in the year. This results in inventory being valued close to the current replacement cost. During periods of inflation, the use of FIFO will result in the lowest estimate of the cost of goods sold among the three approaches, and the highest net income.

Under LIFO, inventory valuation is exactly the opposite of the first-in-first-out method. Here it is assumed that newer inventory is sold first and older remains in inventory. When prices of goods increase, the cost of goods sold in the LIFO method is relatively higher and the ending inventory balance is relatively lower. This is because the cost of goods sold mostly consists of newer higher-priced goods and ending inventory cost consists of older low-priced items.

Under the Weighted Average approach, both inventory and the cost of goods sold are based upon the average cost of all units bought during the period. The weighted average cost per unit is calculated as follows:

Weighted Average Cost Per Unit = Total Cost Of Goods in Inventory / Total Units in Inventory

The weighted average cost as calculated above is multiplied by the number of units sold to get the cost of goods sold and with the number of units in ending inventory to obtain the cost of ending inventory.