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Overview of First-In, First-Out (FIFO)
Definition of
First-In, First-Out (FIFO)
What is First-In, First-Out (FIFO)? First-In, First-Out (FIFO) is one of the common inventory valuation methods used in accounting to determine the value of inventory on hand at the end of an accounting period and the Cost of Goods Sold (COGS) during that period. The FIFO method operates under the assumption that the first units of inventory purchased or produced are the first ones to be sold. This means that the inventory remaining on the Balance Sheet is valued at the cost of the most recently acquired items, while COGS reflects the cost of the oldest items.
Activities Related to
First-In, First-Out (FIFO)
Here is a list of FIFO related activities:Â
Tracking the cost and purchase date of each inventory unit, Applying the "first-in, first-out" cost flow assumption when goods are sold, Calculating the Cost of Goods Sold based on the cost of the oldest inventory items, Valuing ending inventory based on the cost of the most recent purchases, Maintaining detailed inventory records, and Reporting inventory values on the financial statements. Effective bookkeeping is essential for accurate FIFO application.
These activities ensure that inventory and COGS are valued according to the FIFO principle.
The Importance of
First-In, First-Out (FIFO)
The FIFO method is important because it often reflects the actual physical flow of goods for many businesses, especially those dealing with perishable items or products with a limited shelf life, as selling older stock first is a logical business practice. In periods of rising prices (inflation), FIFO typically results in a lower Cost of Goods Sold (as older, cheaper items are expensed) and a higher net income, leading to higher tax liabilities. Conversely, ending inventory on the Balance Sheet is valued at more current costs, which can provide a more realistic representation of inventory's current replacement cost. FIFO is permitted under both GAAP and International Financial Reporting Standards (IFRS).
Key Aspects of
First-In, First-Out (FIFO)
Cost Flow Assumption
Assumes the oldest inventory items are sold first. This is an assumption for costing purposes and may not always match the exact physical movement of goods.
Impact on COGS
In inflationary periods, FIFO results in a lower COGS because older, lower-cost items are assumed sold.
Ending Inventory Valuation
Ending inventory is valued at the most recent purchase costs, generally reflecting current market values more closely than LIFO.
Tax Implications
Higher reported net income (during inflation) can lead to higher income tax expense compared to LIFO.
Concepts Related to
First-In, First-Out (FIFO)
First-In, First-Out (FIFO) is one of the primary Inventory Valuation Methods, alongside Last-In, First-Out (LIFO) and the Weighted-Average Method. The choice of method directly impacts the Cost of Goods Sold (COGS) on the Income Statement and the value of ending Inventory (an asset) on the Balance Sheet. These valuations are crucial for determining profitability.
FIFO Inventory
in Action:
The Adventures of Coco and Cami
Coco needs to make sure her sandwich ingredients are fresh! Professor A explains the FIFO method, showing how assuming the first bread she bought is the first bread she uses helps her value her inventory.
Discover with Coco and Cami how FIFO impacts their cost of goods sold and the value of the supplies they still have on hand for their bustling shops.