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Inventory costing is a method of computing the cost of issued or sold inventory based on some cost flow assumption. There is major three cost flow assumption for this purpose. They are –

a) FIFO

b) LIFO

c) Average cost

Each assumption provides different values for COGS and ending inventory. These assumptions are also affected by the market conditions like rising or falling prices.

The FIFO assumption is based on the first-in-first-out order for applying cost to the issued inventory. LIFO takes the last-in-first order and the average method takes the average value for each sale under perpetual record.

Under declining cost conditions, the current cost would always be lower than the earlier cost. Thus, in order to maximize the gross profit, it is necessary that the cost of goods sold must be lowest.

So as the cost is in a declining condition, the COGS would be lowest only if the issued inventory is valued at the current cost.

This is possible only in the LIFO cost assumption.