Why Inventory Valuation Matters More Than You Think
How you value your inventory directly affects your reported profits, your tax obligations to KRA, and your ability to price products competitively. Choosing the wrong method can lead to overpaying taxes, understating your margins, or making poor restocking decisions based on inaccurate cost data.
The two most common valuation methods used by Kenyan businesses are First-In, First-Out (FIFO) and the Weighted Average Cost method. Each has distinct advantages depending on your industry, product type, and business goals.
Understanding FIFO: First-In, First-Out
Under FIFO, you assume that the oldest inventory items are sold first. When you calculate the cost of goods sold, you use the cost of the earliest purchased items. The remaining inventory on your balance sheet reflects the most recent purchase prices, which typically means your closing stock valuation is closer to current market values.
FIFO Example
Suppose you run a hardware shop and purchase cement in three batches. Batch 1: 100 bags at KES 700 each. Batch 2: 100 bags at KES 750. Batch 3: 100 bags at KES 800. If you sell 150 bags, FIFO assumes you sold all 100 from Batch 1 (KES 70,000) and 50 from Batch 2 (KES 37,500), making your cost of goods sold KES 107,500.
Understanding Weighted Average Cost
The weighted average method calculates a single average cost for all units in stock after each purchase. Every unit is treated as having the same cost, regardless of when it was bought. This method is simpler to implement and works well when your products are interchangeable and prices do not fluctuate dramatically.
Weighted Average Example
Using the same cement example, the weighted average cost per bag is (70,000 + 75,000 + 80,000) / 300 = KES 750 per bag. Selling 150 bags gives you a cost of goods sold of KES 112,500. Notice the difference from the FIFO calculation, which was KES 107,500.
Side-by-Side Comparison
| Factor | FIFO | Weighted Average |
|---|---|---|
| Complexity | Requires tracking each batch separately | Single average cost, simpler to maintain |
| Rising prices impact | Lower COGS, higher reported profit | Moderate COGS, moderate profit |
| Falling prices impact | Higher COGS, lower reported profit | Moderate COGS, moderate profit |
| Balance sheet accuracy | Closing stock reflects current prices | Closing stock is an averaged figure |
| Tax implications (KRA) | May result in higher taxable income when prices rise | Smooths out taxable income over time |
| Best for | Perishable goods, fashion, electronics | Bulk commodities, raw materials, hardware |
| KRA acceptance | Accepted, must be applied consistently | Accepted, must be applied consistently |
Tax Implications for Kenyan Businesses
KRA requires that businesses choose a valuation method and apply it consistently from year to year. You cannot switch between FIFO and weighted average to minimize your tax bill. If you need to change methods, you must notify KRA and provide justification for the change.
During periods of rising prices, which is common in Kenya due to import cost fluctuations and currency movements, FIFO produces a lower cost of goods sold and therefore higher taxable profits. The weighted average method smooths these fluctuations, resulting in more predictable tax obligations. Consult with your accountant to determine which method is more tax-efficient for your specific situation.
KRA requires consistent application of your chosen inventory valuation method. Switching between methods without justification can trigger an audit. Document your method choice and apply it uniformly across all product categories.
Which Method Should You Choose?
If you sell perishable goods, fashion items, or electronics where older stock genuinely moves first, FIFO aligns with your physical stock flow and gives you a more accurate picture of your margins. It is also the better choice if you want your balance sheet to reflect current replacement costs.
If you deal in bulk commodities, raw materials, or products where individual units are interchangeable, the weighted average method is easier to manage and provides stable cost figures for pricing decisions. It is particularly useful for businesses with high transaction volumes where tracking individual batches would be impractical.