FIFO Method

FIFO stands for "first-in, first-out," and assumes that the costs of the first goods purchased are charged to cost of goods sold.

Learning Objective

Describe how a company would value inventory under the FIFO method

Key Points

This method assumes the first goods purchased are the first goods sold. In some companies, the first units in (bought) must be the first units out (sold) to avoid large losses from spoilage.
In periods of rising prices (Inflation) FIFO has higher value of inventory and lower cost of goods sold; in periods of falling prices (deflation) it has lower value of inventory and higher cost of goods sold.
Because a company using FIFO assumes the older units are sold first and the newer units are still on hand, the ending inventory consists of the most recent purchases.

Terms

accounting
The development and use of a system for recording and analyzing the financial transactions and financial status of a business or other organization.
inflation
An increase in the quantity of money, leading to a devaluation of existing money.
FIFO
First in, first out (accounting).

Example

An example of how to calculate the ending inventory balance and cost of goods sold of the period using FIFO -- assume the following inventory is on hand and purchased on the following dates: Inventory of Product X -Purchase date: 10/1/12 -- 10 units at a cost of USD 5 Purchase date: 10/5/12 -- 5 units at a cost of USD 6 On 12/30/12, a sale is made of Product X for 11 units. Under FIFO, it is assumed that 10 units purchased on 10/1/12 (the sale also eliminates this inventory layer) and 1 unit purchased on 10/5/12 were sold The ending inventory balance on the 12/31/12 balance sheet is 4 units at a cost of USD 6, or USD 24 and cost of goods sold on the income statement is USD 56 (10 units * USD 5 + 1 unit * USD 6)

Full Text

What Is FIFO

FIFO stands for "first-in, first-out", and is a method of inventory costing which assumes that the costs of the first goods purchased are those charged to cost of goods sold when the company actually sells goods.

FIFO and LIFO methods are accounting techniques used in managing inventory and financial matters involving the amount of money a company has tied up within inventory of produced goods, raw materials, parts, components, or feed stocks. These methods are used to manage assumptions of cost flows related to inventory, stock repurchases (if purchased at different prices), and various other accounting purposes .

Inventory

Inventory in a warehouse

Assumptions of FIFO

This method assumes the first goods purchased are the first goods sold. In some companies, the first units in (bought) must be the first units out (sold) to avoid large losses from spoilage. Such items as fresh dairy products, fruits, and vegetables should be sold on a FIFO basis. In these cases, an assumed first-in, first-out flow corresponds with the actual physical flow of goods.

Because a company using FIFO assumes the older units are sold first and the newer units are still on hand, the ending inventory consists of the most recent purchases. When using periodic inventory procedure to determine the cost of the ending inventory at the end of the period under FIFO, you would begin by listing the cost of the most recent purchase. If the ending inventory contains more units than acquired in the most recent purchase, it also includes units from the next-to-the-latest purchase at the unit cost incurred, and so on. You would list these units from the latest purchases until that number agrees with the units in the ending inventory.

How is it different?

Different accounting methods produce different results, because their flow of costs are based upon different assumptions. The FIFO method bases its cost flow on the chronological order purchases are made, while the LIFO method bases it cost flow in a reverse chronological order. The average cost method produces a cost flow based on a weighted average of unit costs.

The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the "LIFO reserve. " This reserve is essentially the amount by which an entity's taxable income has been deferred by using the LIFO method.

How to Calculate Ending Inventory Using FIFO

Ending inventory = beginning inventory + net purchases - cost of goods sold

Keep in mind the FIFO assumption: Costs of the first goods purchased are those charged to cost of goods sold when the company actually sells goods.

When Using FIFO

Periods of Rising Prices (Inflation)FIFO (+) Higher value of inventory (-) Lower cost of goods sold
Periods of Falling Prices (Deflation)FIFO (-) Lower value of inventory (+) Higher cost of goods sold

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