Two sellers can buy the exact same product, sell the exact same number of units, and report different gross margin and taxable income for the year, purely because one uses first-in-first-out costing and the other uses weighted average cost. Neither method is wrong. But applying one inconsistently, or switching between them without understanding the effect, produces inventory and COGS figures that do not reflect what actually happened in the business, and can distort margin analysis at exactly the point sellers most need it: when unit costs are moving.
Why the Costing Method Matters at All
When every unit of a product costs exactly the same amount to acquire, the costing method is irrelevant; COGS comes out the same under any method. The method only starts to matter once unit cost changes between purchase batches, which for most e-commerce sellers is the normal state of affairs rather than the exception. Supplier price increases, exchange rate movement on USD-invoiced inventory, freight cost changes, and quantity-based pricing tiers all mean the cost of the units sitting in a warehouse today rarely matches the cost of the units purchased six months ago.
The costing method determines which of those historical costs gets matched against a given sale, which in turn determines the COGS recognized for that sale, the resulting gross margin, and the value assigned to remaining inventory on the balance sheet.
First-In-First-Out (FIFO)
Under FIFO, the cost of the oldest inventory in stock is matched against the units sold first, on the assumption that inventory physically moves in that order (which is also standard practice for perishable and dated goods, though the costing convention applies regardless of actual physical flow).
In a period of rising costs, FIFO matches older, lower costs against current sales, which produces a higher gross margin and higher taxable income in that period, while the remaining inventory on the balance sheet is valued at more recent, higher costs. In a period of falling costs, the effect reverses: FIFO produces lower margin in the current period, while the remaining inventory reflects more recent, lower costs.
FIFO is the more common default in accounting software and tends to track closely with actual physical inventory rotation for most e-commerce sellers, since most operators do try to sell older stock before newer stock arrives, particularly for products with any shelf life or packaging that can date visibly.
Weighted Average Cost
In a perpetual inventory system, moving weighted average cost recalculates a single blended unit cost each time new inventory is received, based on the total cost of all units on hand (old and new combined) divided by the total quantity on hand. In a periodic system, the weighted average can instead be calculated across the units available for sale during the period. Either way, the blended cost is then applied to units sold rather than drawing from a specific FIFO cost layer.
This method smooths out the effect of cost fluctuations between batches. A seller who received a large shipment at a lower cost followed by a smaller shipment at a higher cost will not see COGS swing sharply from one sale to the next; the blended average moves gradually as new costs enter the calculation. This tends to produce a steadier gross margin trend across a reporting period, particularly useful for sellers dealing with frequent, irregular cost changes across many SKUs.
Weighted average is also generally simpler to reconcile for a seller who does not track individual purchase batches or lot numbers closely, since the running average absorbs new cost data automatically rather than requiring the accounting system to track a queue of specific cost layers.
How the Choice Affects Reported Numbers
Consider a seller who purchased 100 units at CAD $10 landed cost, then a further 100 units at CAD $12 landed cost after a supplier price increase, and sold 120 units in the period.
Under FIFO, the 120 units sold are matched first against the 100 units at $10, then 20 units at $12, producing COGS of CAD $1,240 and leaving 80 units in inventory valued at $12 each ($960).
Under weighted average, the blended cost across 200 units totalling CAD $2,200 is $11 per unit. COGS for 120 units sold is CAD $1,320, and the remaining 80 units in inventory are valued at $11 each ($880).
Same purchases, same units sold, different COGS (CAD $1,240 versus CAD $1,320), different gross margin, and different inventory asset value on the balance sheet. Neither number is incorrect; they reflect two different, both acceptable, conventions for matching cost against revenue.
Consistency Matters More Than Which Method Is Chosen
CRA does not mandate a single inventory costing method for all businesses, but the tax rules do expect inventory valuation methods to be carried forward consistently rather than switched opportunistically to manage reported income in a given period. A change in inventory valuation method is a change in accounting policy, and if it materially affects reported income, it should be flagged to the accountant preparing the return rather than made silently inside the accounting or inventory software.
Most accounting and inventory management platforms let the costing method be set once at setup and then apply it automatically going forward, which is the intended way to use either method: pick one that fits how the business actually operates and its bookkeeping capacity, and apply it consistently across comparable products and periods.
Which Method Fits Which Kind of Seller
A seller with a small number of SKUs, infrequent restocking, and a habit of tracking purchase batches individually (or whose inventory management software does this automatically) can use FIFO without much added complexity, and it tends to mirror actual inventory rotation reasonably well.
A seller running many SKUs with frequent restocking, especially where per-unit costs shift often due to currency movement on foreign supplier invoices or changing freight rates, may find weighted average produces steadier, easier-to-interpret margin trends without requiring the accounting system to track individual cost layers per batch.
Neither factor is decisive on its own. The more important point is that whichever method is chosen should be applied consistently to comparable inventory and carried forward consistently, since an undocumented mix of methods across similar products, or a method that changes year to year, breaks the comparability that margin analysis depends on.
Interaction with Landed Cost and Inventory Reconciliation
The costing method operates on top of whatever unit cost has already been established through the landed cost calculation, covered in the landed cost guide. Freight, duties, and brokerage fees need to be allocated into the per-unit cost before FIFO or weighted average logic is applied to that cost across sales; the costing method decides which cost layer is matched to a sale, not what the underlying cost of a unit actually is.
The costing method also has to align with how inventory is reconciled against a physical or perpetual count, covered in the inventory reconciliation guide. An inventory system tracking quantity correctly but applying inconsistent costing will still produce a balance sheet inventory value that does not reflect the actual cost of goods on hand, even if the unit count itself is accurate.
Setting This Up Correctly
Before choosing or changing a costing method, confirm:
- Which method the current accounting or inventory software defaults to, and whether it can be configured explicitly rather than left on a default
- Whether the same method is applied consistently across all SKUs, not just the highest-volume products
- Whether the chosen method is documented so it carries forward correctly if bookkeeping responsibilities change hands, referenced in the switching accountants situation if that applies
- Whether a change from one method to another is being considered for a legitimate operational reason, and if so, that it is flagged to the accountant preparing the year’s return rather than applied silently mid-year
Get in touch if your current inventory costing setup is producing margin numbers that do not match what you expect from the business, or if you are setting up a new inventory system and want the costing method chosen correctly from the start.