Cost layering determines which inventory items to expense when a sale is made. This is important because items are often purchased as different amounts over time and “layers” build up as inventory accumulates before being sold. The three most common methods are:

• FIFO or First In First Out assumes that the oldest purchases on hand are sold first. This usually most closely reflects reality and is the most commonly adopted method.
• LIFO or Last In First Out assumes that the most recent purchases are sold first and the oldest inventory remains in stock. This method is only used in the United States for income tax savings purposes. Assuming that costs increase over time means that expensing recently purchased inventory first will generate higher costs in the

present and thus lower taxes.

• The Weighted Average method does away with layers all together and simply averages the total cost of all purchased inventory. Thus the average cost per unit can increase or decrease over time with new additions.