METHOD

ADVANTAGES

DISADVANTAGES

FIFO

Ending inventory amount on balance sheet approximates current replacement costs.

Passes through effects of inflation and deflation to gross profit reported on income statement.

LIFO

Matches current costs against current revenues on income taxes.

During inflationary periods, reduces income taxes.

Ending inventory amount on income statement may be substantially different from current replacement cost.

AVERAGE COST

Easy to understand.

Yields same answer whether prices start at $1 and increase to $2

or start at $2 and decrease to $1.

Ending inventory amount on income statement may not represent current replacement cost.

Lose tax advantage available from LIFO when prices are rising.