Average Cost accounting calculates profit or loss on each trade according to the average price paid for all stocks in a particular holding.
FIFO / LIFO accounting allocates disposals of shares against previous acquisitions, calculating profit or loss on each trade according to the price paid for those acquisitions. First In First Out (FIFO) allocates a disposal of shares against the earliest unallocated acquisition. Last In First Out (LIFO) allocates a disposal of shares against the most recent unallocated acquisition.
For example: if 100 shares are purchased at 400 pence each, then a further 150 shares at 600p each. A total of 250 shares has been purchased at a cost of £1300. If 200 shares are sold at 530p each for a total of £1060, the profit or loss on the transaction can be calculated in the following three ways.
Average cost The average cost per share for the current holding is 520p. On this calculation, the notional cost of the 200 shares was £1040. A £20 profit will be recorded on the transaction.
First in First Out The 200 shares being sold are allocated against all 100 of the shares purchased at 400p each, and100 of the 150 shares purchased at 600p each. On this calculation, the notional cost of the 200 shares was £1000. A £60 profit will be recorded on the transaction.
Last In First Out The 200 shares being sold are allocated against all the 150 shares purchased at 600p each, and 50 of the 100 purchased at 400p each. On this calculation, the notional cost of the 200 shares was £1100. A £40 loss will be recorded on the transaction.