FIFO vs Average Cost for Amazon Inventory: Which Method Is Right?
Nobody starts an Amazon business thinking, “I can’t wait to decide on an inventory costing method.” But here you are, because at some point someone told you it matters — or you noticed your P&L doesn’t make sense — and they were right.
Why Inventory Costing Methods Exist
You buy inventory at different prices across different purchase orders. When you sell a unit, the accounting question is: which cost do you assign to that sale?
You can’t track individual units through a fulfillment center — Amazon doesn’t give you that data. So you use a systematic method to determine cost. FIFO and weighted average cost are the two standard options for most Amazon sellers. LIFO (Last In, First Out) is technically allowed under US GAAP but prohibited under IFRS and widely impractical for FBA operations, so we’ll skip it.
Your method affects:
– COGS on your income statement
– Ending inventory value on your balance sheet
– Gross profit and taxable income
– Comparability of margins across periods
Once you pick a method, the IRS requires you to use it consistently. Switching requires IRS approval (Form 3115). This isn’t a decision to make on a whim or reverse if you don’t like the tax outcome one year.
What Is FIFO for Amazon Inventory?
FIFO stands for First In, First Out. The assumption is that the oldest inventory you purchased is the first inventory you sold.
In practice: if you bought 500 units at $10.00 in January and 500 more at $13.00 in March, and you sell 600 units in Q2, FIFO assumes you sold all 500 January units first plus 100 of the March units.
COGS under FIFO:
– 500 units × $10.00 = $5,000
– 100 units × $13.00 = $1,300
– Total COGS: $6,300
Ending Inventory under FIFO:
– 400 units × $13.00 = $5,200
FIFO matches the way Amazon actually moves inventory — older stock generally ships first. It’s also the method that makes your balance sheet look better in an inflationary environment, because ending inventory is valued at the most recent (higher) cost.
What Is Weighted Average Cost for Amazon Inventory?
Weighted average cost (also called “average cost” or “AVCO”) blends all your per-unit costs into a single running average. Every time you receive new inventory, the average cost per unit is recalculated.
Using the same example:
– 500 units @ $10.00 + 500 units @ $13.00 = 1,000 units for $11,500
– Average cost per unit: $11.50
COGS under Average Cost:
– 600 units × $11.50 = $6,900
Ending Inventory under Average Cost:
– 400 units × $11.50 = $4,600
Average cost smooths out price volatility. If your supplier prices fluctuate a lot — or you’re dealing with unpredictable freight rates — average cost can make your margins more stable quarter to quarter, even when costs are moving around.
FIFO vs Average Cost: A Direct Comparison
| Factor | FIFO | Average Cost |
|---|---|---|
| COGS (in rising cost environment) | Lower | Higher |
| Ending Inventory (rising costs) | Higher | Lower |
| Taxable Income (rising costs) | Higher | Lower |
| Margin Stability | More volatile | Smoother |
| IRS Acceptance | Yes | Yes |
| Complexity | Moderate | Lower |
| Balance Sheet Strength | Better | Weaker |
The key insight: in an inflationary environment (where your costs are going up over time), FIFO produces lower COGS, higher taxable income, and a higher-valued balance sheet. Average cost does the opposite — higher COGS, lower taxable income.
When costs are decreasing (rare but happens with some product categories), the effects reverse.
How Each Method Affects Your Amazon Business Specifically
Tax Planning
If you’re growing fast and reinvesting cash, you probably want to minimize current-year tax liability. In a rising cost environment, weighted average cost will typically produce higher COGS, which reduces taxable income.
That said, this is a long-term decision — you’re not just managing this year’s taxes. The method should fit how you run your business, not just optimize one tax year.
Valuing Your Business for Sale
Buyers and lenders look at your balance sheet. Higher ending inventory values (FIFO in inflationary environments) make the balance sheet stronger. If you’re planning to sell your Amazon business or raise capital, that matters.
Multi-SKU Complexity
If you have 50 SKUs across multiple purchase orders per year, average cost is significantly easier to maintain. FIFO requires tracking cost layers by purchase order, which adds accounting complexity.
Most small-to-mid-size Amazon operations use average cost for simplicity. FIFO is more common in businesses with higher margins, sophisticated accounting systems, or a near-term exit in mind.
What Most Amazon Sellers Actually Do
The honest answer: most 7-figure Amazon sellers are not using either method correctly. They’re running on cash-basis accounting, treating inventory purchases as expenses, and getting a COGS number that’s either wrong or nonexistent.
If that’s you, the first step isn’t choosing between FIFO and average cost. The first step is switching to accrual accounting and building a proper inventory accounting workflow.
See how Amazon seller accounting works →
Once you’re on accrual, then you make the method decision.
MuseMinded is an accounting firm specializing in Amazon FBA, Shopify, and DTC ecommerce brands. We help clients set up their books correctly from the start — including implementing the right costing method in QuickBooks or Xero so it actually works as you scale.
How to Implement FIFO or Average Cost in Your Accounting System
QuickBooks Online
QBO uses average cost for inventory by default. There’s no native FIFO option in QBO. If FIFO is important to your business, you’ll either need a third-party inventory management system that tracks cost layers, or you’ll need to reconcile outside of QBO.
Xero
Xero also defaults to average cost (AVCO). Similar limitations apply — if you need true FIFO, you’ll need an add-on like Cin7, Katana, or DEAR Inventory.
Dedicated Inventory Software
Tools like Linnworks, Skubana, or Inventory Planner can track cost layers at the SKU and PO level, giving you FIFO-accurate COGS that feeds into your accounting system. This is the right setup for a seller with meaningful cost variability across purchase orders.
For most sellers at the 7-figure level, average cost in QBO or Xero — properly configured — is accurate enough and far more practical to maintain.
When to Switch Methods
The IRS treats a change in inventory costing method as a change in accounting method. You need to file Form 3115 and typically get approval. This isn’t as scary as it sounds — it’s routine — but it does require a CPA to handle it correctly.
Don’t switch because one method looks better for one quarter. Switch if:
– Your current method no longer reflects how your business operates
– You’re preparing for an acquisition or exit
– Your accounting system is changing and you’re rebuilding from scratch
– You’re shifting from cash to accrual and starting fresh
FIFO vs Average Cost: What We Recommend for Amazon Sellers
For most Amazon FBA sellers at the 7-figure level: weighted average cost is the right starting point. It’s simpler, supported natively by QuickBooks and Xero, and produces stable margins that are easier to analyze month-over-month.
If you’re above $5M in revenue, have significant cost variability across purchase orders, and are thinking about an exit in the next 2–3 years: talk to a CPA about whether FIFO and a proper inventory management system makes sense.
The method matters less than the consistency. Pick one. Set it up correctly. Don’t change it without a real reason.
Frequently Asked Questions
What is the difference between FIFO and average cost for Amazon inventory?
FIFO assumes the oldest inventory is sold first; average cost blends all unit costs into a running average. In a rising cost environment, FIFO produces lower COGS and higher taxable income. Average cost produces higher COGS and lower taxable income.
Which inventory costing method do most Amazon sellers use?
Most Amazon sellers use weighted average cost, primarily because it’s the default in QuickBooks Online and Xero. FIFO requires more sophisticated tracking, usually via a dedicated inventory management system.
Does the IRS allow both FIFO and average cost for Amazon businesses?
Yes. Both methods are accepted by the IRS. However, once you choose a method, switching requires filing Form 3115 (Application for Change in Accounting Method) and IRS approval.
How does my inventory costing method affect my taxes?
In an inflationary environment (rising costs), average cost produces higher COGS, which reduces gross profit and taxable income. FIFO produces lower COGS and higher taxable income. The difference can be significant depending on cost volatility and inventory volume.
Can I use FIFO in QuickBooks Online for Amazon inventory?
QuickBooks Online uses average cost by default and does not support native FIFO tracking. To implement FIFO, you need a third-party inventory management system (like Cin7 or DEAR Inventory) that tracks purchase order cost layers and syncs with QBO.
When should an Amazon seller switch inventory costing methods?
Consider switching if you’re preparing for a business sale (FIFO may strengthen your balance sheet), if you’re rebuilding your accounting system from scratch, or if your current method is producing inaccurate results. Always consult a CPA before switching — it’s a formal accounting method change that requires IRS notification. — ## Build a Financial Foundation That Actually Holds Picking FIFO or average cost is one piece of getting your Amazon books right. The bigger issue is whether your entire accounting setup — chart of accounts, COGS tracking, inventory reconciliation — is built for an FBA operation or just cobbled together from a generic small business template. [See how MuseMinded builds Amazon P&Ls →](/amazon-accountant) [More on Amazon seller accounting fundamentals →](/amazon-seller-accounting)
MuseMinded is an accounting firm specializing in Amazon FBA, Shopify, and DTC ecommerce brands. If your books aren’t telling you the full story — we can fix that.
