What is the FIFO Method?
The FIFO method (First-In, First-Out) is one of the most popular inventory valuation and accounting approaches. It assumes that the oldest items purchased or produced are the first ones sold, while the most recent inventory remains in stock. This makes FIFO particularly suitable for businesses where goods are perishable or fast-moving.
Definition of First-In First-Out (FIFO)
The fifo full form is First-In, First-Out. In simple terms, the first goods that enter inventory are the first to be sold or used. This approach closely mirrors the actual physical flow of products in many businesses, especially in food, retail, and manufacturing sectors.
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How the FIFO Method Works in Accounting
In accounting, the fifo meaning is tied to the way cost of goods sold (COGS) and ending inventory are calculated. Under FIFO, the oldest purchase costs are matched against current sales. This means that during times of rising prices, the cheaper, older costs are expensed first, leading to a higher reported profit and higher inventory valuation
Formula for Calculating FIFO Inventory and COGS
The first in first out fifo method formula to calculate COGS is:
COGS = Cost of Oldest Inventory Items Sold × Quantity Sold
Ending Inventory is calculated using the costs of the most recent purchases that remain unsold. This method ensures transparency and ease of calculation.
Example of the FIFO Method
Imagine a business purchased the following stock:
100 units @ ₹50 each
100 units @ ₹60 each
If 120 units are sold, FIFO assumes the first 100 units sold are from the ₹50 batch, and the next 20 units are from the ₹60 batch.
COGS = (100 × ₹50) + (20 × ₹60) = ₹5,000 + ₹1,200 = ₹6,200
Ending Inventory = 80 units @ ₹60 = ₹4,800
This example shows how FIFO impacts reported profit and inventory value.
Advantages of Using FIFO
- Simplicity: Easy to understand and apply.
- Reflects actual flow of goods: Matches how inventory is used in most industries.
- Higher inventory valuation: Especially beneficial in times of inflation.
- Globally accepted: Permitted under both IFRS and GAAP accounting standards.
Limitations of the FIFO Method
- Inflation impact: Can overstate profits when prices are rising.
- Tax implications: Higher profits may lead to higher taxes.
- Not suitable for all industries: In some cases, physical stock usage may differ; some may prefer other methods .
When Should Businesses Use FIFO?
FIFO is ideal for businesses that deal with:
- Perishable goods like food, beverages, or pharmaceuticals.
- Fast-moving consumer goods where old stock must be sold first.
- Companies that want a true reflection of stock value on their balance sheet.
On the other hand, industries with highly volatile raw material prices may prefer other methods like LIFO (Last-In, First-Out).
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Conclusion
The first in first out method is one of the simplest and most widely used inventory valuation techniques. It provides a realistic view of stock usage, ensures compliance with global accounting standards, and helps maintain transparency in reporting. While it may increase taxable profits during inflation, FIFO remains a reliable choice for businesses that prioritize accurate inventory valuation and easy application.
