FRS 102 allows only two cost formulas for stock that is ordinarily interchangeable: first in, first out (FIFO) and weighted average cost. Items that are not interchangeable, or are produced for specific projects, must be costed by specific identification. Last in, first out (LIFO) is expressly prohibited by paragraph 13.18, and HMRC does not accept it for tax either.

What does a cost formula actually do?

A business that buys the same item several times at different prices needs a rule for deciding which of those prices sits in closing stock and which goes to cost of sales. That rule is the cost formula. It does not change how many units are on hand, only which purchase costs are attached to them. In a period of rising prices, the choice moves profit between this year and next.

The formula is applied before the separate test of comparing cost with selling price less costs to complete and sell. That second step, and what can be included in cost in the first place, are covered in stock valuation: lower of cost and net realisable value. This page deals only with the arithmetic of attaching costs to units.

Which formulas does FRS 102 allow?

Paragraph 13.17 of FRS 102 requires specific identification of individual costs for items that are not ordinarily interchangeable, and for goods or services produced and segregated for specific projects. Paragraph 13.18 then requires all other stock to be measured using FIFO or the weighted average cost formula. It adds three rules:

  • the same formula must be used for all stock having a similar nature and use to the entity;
  • for stock with a different nature or use, different formulas may be justified; and
  • LIFO is not permitted.

FRS 105 contains the same wording for micro entities at paragraphs 10.16 and 10.17, so there is no simpler option at the smallest end; see FRS 105 and micro entity accounts. The IFRS Foundation’s summary of IAS 2 Inventories likewise assigns cost by specific identification or by the FIFO or weighted average formula.

Paragraph 13.16 also allows techniques such as standard costing, the retail method or most recent purchase price, but only if the result approximates cost. These are shortcuts for measuring cost, not alternatives to the formulas. A standard cost that has not been revised for a year of price rises will no longer approximate FIFO or average cost.

How do FIFO and weighted average compare in practice?

Illustration only. A wholesaler starts the year with no stock and buys one product three times. It sells 250 units in May, between the second and third purchases.

Date Units bought Price per unit Cost
January 100 £10 £1,000
March 200 £12 £2,400
June 100 £15 £1,500
Total 400 £4,900

At the year end 150 units remain. The three methods give:

Method Closing stock Cost of sales
FIFO: the oldest units are treated as sold first, so stock is the 100 June units and 50 March units £2,100 £2,800
Periodic weighted average: £4,900 divided by 400 units gives £12.25 a unit £1,837.50 £3,062.50
Moving weighted average: the May sale is costed at the average after March of £11.33, then the June purchase is added £2,066.67 £2,833.33
Periodic LIFO, shown only for comparison: stock is the 100 January units and 50 March units £1,600 £3,300

FIFO produces the highest closing stock and profit when prices are rising, because the most recent and most expensive purchases stay on the balance sheet. A periodic average recalculated once a year and a moving average recalculated after every purchase give different answers when sales happen part way through the year. FRS 102 names the weighted average formula without prescribing how often the average is updated, so the approach chosen should be applied consistently and should suit the stock system in use.

When must specific identification be used?

Specific identification is required, not optional, where items are not ordinarily interchangeable. Examples are used vehicles, artworks, bespoke furniture, individual properties held by a developer and a contractor’s materials bought for a particular job. Each item carries its own actual cost.

The reverse is also true. Using specific identification for large quantities of identical items would let a business choose which units it says it has sold and so manage its profit. That is why paragraph 13.18 directs interchangeable stock to FIFO or weighted average.

Why is LIFO not permitted?

Company law on its own would allow it. Schedule 1 paragraph 28 of both the small companies regulations (SI 2008/409) and the large and medium companies regulations (SI 2008/410) lists FIFO, LIFO, a weighted average price and any other method reflecting generally accepted best practice. FRS 102 is narrower, and a company preparing FRS 102 accounts must follow paragraph 13.18.

The objection to LIFO is that, in rising prices, it leaves the oldest costs on the balance sheet, so stock can be stated at prices years out of date while cost of sales is inflated. In the example, LIFO reports closing stock of £1,600 for units that cost £2,100 on a FIFO basis. HMRC’s Business Income Manual at BIM33120 explains the tax position through the Privy Council decision in Minister of National Revenue v Anaconda American Brass Ltd [1956]: what is valued at the start and end of a period has long been taken to be the actual stock so far as it can be ascertained. BIM33125 lists LIFO and base stock among the bases not allowable for tax.

For large and medium companies, Schedule 1 paragraph 28(3) to (5) of SI 2008/410 adds a disclosure: where the amount shown for stock under a permitted method differs materially from replacement cost at the balance sheet date, or from the most recent actual purchase price or production cost if the directors consider that a more appropriate comparison, the difference must be disclosed in a note. The small companies regulations do not include this requirement.

Can a business change its cost formula?

Choosing between FIFO and weighted average is an accounting policy choice. Under paragraph 10.8 of FRS 102, a policy may be changed only if an FRS requires it or if the change results in reliable and more relevant information. Paragraph 10.10 confirms that changing a previous choice where an FRS allows options is a change in accounting policy, and paragraph 10.11(d) means it is applied retrospectively under paragraph 10.12, restating comparatives so far as practicable. Changing systems is not, on its own, a reason. The mechanics are explained in accounting policies, estimates and errors.

Paragraph 13.22(a) requires the accounting policies for stock, including the cost formula used, to be disclosed, so a change will be visible in the notes.

For tax, BIM33115 says the valuation in GAAP compliant accounts should generally be accepted and that the policy should be consistent unless the reasons for change outweigh the need for consistency. A change from one valid basis to another is a change of basis: section 180 of the Corporation Tax Act 2009 applies to a change of accounting policy, and section 181 brings the resulting adjustment into account on the first day of the first period on the new basis. HMRC’s guidance on valid to valid changes is at BIM34040.

What mistakes come up most often?

  • Leaving an old standard cost in the system after significant price changes, so it no longer approximates cost.
  • Using different formulas for similar stock in different branches or group companies without a difference in nature or use.
  • Applying specific identification to interchangeable goods, which allows profit to be managed.
  • Running a LIFO style calculation in management accounts and carrying it into the statutory accounts.
  • Switching between periodic and moving average from year to year.
  • Changing formula without restating comparatives or explaining the change.

Goods withdrawn for personal use are valued differently for tax; see goods taken for own use.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.