On 31 March your godown holds 200 tins of edible oil. You bought them over the year at four different rates, from ₹1,900 to ₹2,250 a tin. What are they worth in the balance sheet? Under FIFO, ₹4,50,000. Under weighted average, ₹4,19,167. Same tins, same godown, a ₹30,833 gap in your profit.
FIFO (first in, first out) assumes the oldest stock is sold first, so closing stock carries the latest purchase rates. Weighted average spreads the total cost evenly across every unit you had. Both are allowed in India for books and for income tax. LIFO is not.
The right choice depends less on theory and more on how your prices move, how your goods age, and how steadily you can keep the method year after year. Here is how I would think it through with a trading client.
What is the difference between FIFO and weighted average?
Both methods answer one question: when you sell a unit, which purchase cost goes out with it?
FIFO sends out the cost of the oldest lot first. Whatever is left at year-end is valued at your most recent purchase rates.
Weighted average pools all units and their cost, divides one by the other, and uses that single rate for both sales and closing stock.
Weighted average comes in two forms. The periodic version works out one average for the whole year (or month). The moving version recalculates the average after every purchase, so each sale picks up the rate prevailing on that date. The two can give different closing figures, so check which one your books follow before you compare years.
When prices are flat, the methods land close together. When prices rise through the year, FIFO shows higher closing stock and higher profit. When prices fall, FIFO shows the lower figure.
Which stock valuation methods are allowed in India?
For your books, AS 2 (Valuation of Inventories) applies to most non-corporate businesses and smaller companies, and Ind AS 2 to companies on Ind AS. Both value stock at the lower of cost and net realisable value. Both permit specific identification for items that are not interchangeable, and FIFO or weighted average for everything else. Neither allows LIFO.
For income tax, the Income-tax Act, 2025 has been in force since 1 April 2026. Section 277 of the new Act (which takes the place of section 145A of the 1961 Act) says inventory is valued at the lower of actual cost or net realisable value, worked out under the Income Computation and Disclosure Standards notified under section 276(2). ICDS II on valuation of inventories allows the same cost formulas as AS 2: specific identification, FIFO or weighted average, with LIFO excluded.
One rule from both AS 2 and ICDS II matters in practice. Use the same formula for all stock of a similar nature and use. You can value tiles on FIFO and adhesives on weighted average if they are different kinds of stock, but you cannot switch formulas item by item to suit the year's profit.
A worked example: one year at an edible oil wholesaler
Say you run an edible oil wholesale business in Rajkot that trades in 15-litre tins. All figures below exclude GST, because you claim input tax credit on purchases.
Date | Entry | Tins | Rate (₹) | Amount (₹) |
|---|---|---|---|---|
1 April | Opening stock | 200 | 1,900 | 3,80,000 |
10 April | Purchase | 300 | 2,000 | 6,00,000 |
15 June | Purchase | 400 | 2,150 | 8,60,000 |
20 September | Purchase | 300 | 2,250 | 6,75,000 |
Total | Available for sale | 1,200 | 25,15,000 |
You sold 1,000 tins during the year for ₹24,00,000. That leaves 200 tins on 31 March.
Closing stock under FIFO
The 200 tins left are treated as part of the latest lot, bought at ₹2,250. Closing stock is 200 × 2,250 = ₹4,50,000. Cost of goods sold is 25,15,000 − 4,50,000 = ₹20,65,000, and gross profit is 24,00,000 − 20,65,000 = ₹3,35,000.
Closing stock under periodic weighted average
The average cost is 25,15,000 ÷ 1,200 = ₹2,095.83 a tin. Closing stock is 200 × 2,095.83 = ₹4,19,167. Cost of goods sold is ₹20,95,833, and gross profit is ₹3,04,167.
The gap is ₹30,833, all of it timing. FIFO books that profit this year. Weighted average carries it into the next year through a lower opening stock. Over the life of the business the total profit is the same, but the year in which you pay tax on it is not.
Then check net realisable value
Suppose oil prices drop in March and you can sell a tin for only ₹2,100, with about ₹30 a tin in freight and selling costs. Net realisable value is ₹2,070 a tin, or ₹4,14,000 for 200 tins. That is below cost under both methods, so both write closing stock down to ₹4,14,000. FIFO takes a ₹36,000 write-down; weighted average takes ₹5,167. Gross profit becomes ₹2,99,000 either way. A falling market narrows the difference between methods, which is why the NRV check is not optional.
Which method suits which kind of trader?
There is no single right answer, but the pattern of your trade usually points one way.
Type of business | Usually fits | Why |
|---|---|---|
Pharma, FMCG and food distributors | FIFO | Goods have expiry dates and physically move oldest first, so the costing matches the godown. |
Steel, edible oil, cotton yarn and other commodity traders | Weighted average | Rates swing week to week; averaging smooths margins and stops one cheap lot from distorting profit. |
Hardware, plywood and tiles dealers with many SKUs | Weighted average | Lots get mixed on racks, and tracking which batch went out is not practical. |
Mobile phones, electronics and vehicles | Specific identification | Each unit has an IMEI or serial number, so its actual cost can be traced. |
Two more points decide close calls. If your bank asks for monthly stock statements against a cash credit limit, pick the method you can run every month without manual work. And if you file under presumptive taxation, the method still matters for your books and your bank, even though profit for tax is estimated differently.
Does GST change the cost of your stock?
In the books, no. Under AS 2, taxes that you later recover are left out of cost. If you claim ITC on a purchase, the GST is not part of the stock value. Freight inward, loading and unloading, and any non-creditable tax do go into cost. If you are a composition dealer or the credit is blocked, the GST you paid stays in cost because you cannot recover it.
For income tax, section 277(1)(ii) of the 2025 Act asks for purchases, sales and inventory to be adjusted to include any tax, duty, cess or fee actually paid or incurred. Most traders keep their books net of GST and make this adjustment only in the tax computation. Because purchases, sales, opening stock and closing stock are all adjusted, the effect on taxable profit is usually nil. Your CA should still show the working on file.
Can you change your stock valuation method later?
Yes, but not casually. ICDS II says the method shall not be changed without reasonable cause. AS 2 and the general rules on accounting policies expect consistency and a disclosure of the effect in the year of change.
Reasonable causes include a new line of business, a switch to batch-wise tracking for expiry, or moving to a new accounting standard. Wanting lower profit in a good year is not one of them. From tax year 2026-27, the tax audit report is filed in Form 26 instead of Form 3CD, and it asks about how inventory is valued, so an unexplained change will show up.
If you do change, quantify the effect on opening and closing stock, record why, and apply the new method from a clear date, ideally the first day of a financial year.
A year-end stock valuation routine for traders
Post every purchase bill up to 31 March, including late freight and debit notes, so each lot has its full cost.
Count physical stock in each godown and match quantities with the books before you touch values.
Confirm the cost formula in use (FIFO, moving average or periodic average) and that it is the same as last year.
List slow-moving, damaged and near-expiry items and estimate their net realisable value item by item.
Write down any item whose net realisable value is below cost, and note the basis for the estimate.
Reconcile the closing stock figure with the stock statement you gave your bank for March.
Share the valuation working with your CA for the section 277 tax adjustment and the audit file.
If you make things as well as trade, costing starts earlier, at the bill of materials. Our guide on BOM costing for small manufacturers covers that side.
Where hisabkitab fits in
Stock valuation is only as good as the purchase data under it. hisabkitab reads purchase bills and PDFs with AI OCR, so each lot's quantity, rate and HSN code reach the books without retyping, and it flags duplicate invoices before they inflate your stock cost. If you hold goods in more than one godown, multi-location accounting keeps branch transfers separate from purchases.
At year-end you get the P&L, balance sheet and Schedule III reports from the same books, and you can ask Claude or ChatGPT read-only questions on your data, such as closing stock by item. If your history sits in Tally, one-click data import with AI ledger mapping brings it across. See how it works for trading businesses or browse the full accounting software features.
Frequently asked questions
Is LIFO allowed in India?
No. AS 2, Ind AS 2 and ICDS II all exclude LIFO. You can use specific identification, FIFO or weighted average.
Which method gives lower tax, FIFO or weighted average?
When purchase prices are rising, weighted average usually shows lower closing stock and lower profit for the year. The difference reverses in later years, so it shifts tax rather than saving it.
Can I use FIFO for some items and weighted average for others?
Yes, if the items are different in nature or use. Stock of a similar nature and use must follow the same formula.
Should closing stock include GST?
Not in your books if you claim input tax credit on it. For the income tax computation, section 277 of the Income-tax Act, 2025 requires an inclusive adjustment, which usually has no net effect on taxable profit.
What is net realisable value?
It is the estimated selling price less the costs needed to complete and sell the goods. If it falls below cost, closing stock is valued at net realisable value.
How often should a trader value stock?
At least at year-end for the accounts and tax. Most traders with a bank limit also value it monthly for the stock statement.
Start a free trial or compare plans to keep your purchase lots, stock and year-end reports in one set of books.
