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Two branches can sell the same product in the same quantities and report different gross margins. Before crediting one team with better performance, check how each branch assigned inventory costs to sales. The costing method affects when purchase cost changes reach the profit report, which can influence decisions about pricing, purchasing and product mix.
Match the cost formula to the stock
First in, first out (FIFO) assigns the oldest available costs to sales first. When purchase costs rise, older cost layers can temporarily support a higher reported margin while newer, higher costs remain in closing stock. Weighted average blends eligible purchase costs. A periodic average is calculated for a reporting period, while a moving average updates as additional stock is received. Specific identification traces the actual cost of an individual item and suits stock that is not ordinarily interchangeable, such as bespoke equipment.
For entities applying IAS 2, FIFO and weighted average are cost formulas for ordinarily interchangeable items. Inventory is measured at the lower of cost and net realisable value. A costing formula therefore needs a separate review for damaged, obsolete or slow-moving goods whose recoverable value has fallen.
IFRS Foundation guidance on IAS 2 Inventories
One sale with two different margin results
A distributor receives two equal lots of identical filters before making a sale. The second lot has a higher unit cost. It sells exactly one lot’s worth, and sales revenue is the same under both methods.
Under FIFO, cost of sales reflects the first lot’s lower cost and closing inventory holds the second lot’s higher cost. Under weighted average, each lot’s worth carries the same blended cost because both lots were on hand before the sale. Compared with FIFO, weighted average reports lower gross profit and lower closing inventory in this example. Units sold, revenue and supplier payments stay the same.
Use the right cost for the decision
The distributor’s sales manager might see the FIFO margin and assume there is room for a discount. Before offering it, check what the next replenishment will cost. Keep the recorded gross margin for explaining period performance and show a separate margin using current replacement cost when evaluating new orders. Label that management measure clearly so readers can reconcile it to the accounts.
For branches selling the same kind of stock, apply the reporting policy consistently. Investigate differences in freight, receipt timing, returns and cost adjustments before comparing performance. Reconcile the inventory valuation report to the general ledger at close and review backdated entries and negative stock that can distort cost assignment.
Indicators to review at month end
Gross margin percentage. Divide revenue less cost of sales by revenue. Review by product and branch alongside unit sales to see whether the movement came from volume, selling price or assigned cost.
Landed cost variance. Compare actual unit landed cost with the planned cost for each receipt. Review recurring differences in supplier charges, freight and other attributable costs.
Inventory record accuracy. Divide items counted without a quantity variance by all items counted. Investigate differences before using the valuation report to assess margin or stock levels.
Inventory turnover. Divide period cost of sales by average inventory value. Pair it with units sold and stock ageing because the cost formula affects both inputs.
If stock values and margins are hard to reconcile across branches, enquire with SERPA for a tailored quote to review your inventory controls, costing setup and management reports.