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FIFO Method - AccountingTools
http://www.accountingtools.com/fifo-method[3/29/2015 11:40:23 AM]
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Home >> Inventory Accounting Topics
The First-in, First-out Method (FIFO) | FIFO Inventory Method
Overview of the First-in, First-out Method
The first in, first out (FIFO) method of inventory valuation is a cost flow assumption that the
first goods purchased are also the first goods sold. In most companies, this assumption
closely matches the actual flow of goods, and so is considered the most theoretically correct
inventory valuation method. The FIFO flow concept is a logical one for a business to follow,
since selling off the oldest goods first reduces the risk of obsolescence.
Under the FIFO method, the earliest goods purchased are the first ones removed from the
inventory account. This results in the remaining items in inventory being accounted for at
the most recently incurred costs, so that the inventory asset recorded on the balance sheet
contains costs quite close to the most recent costs that could be obtained in the
marketplace. Conversely, this method also results in older historical costs being matched
against current revenues and recorded in the cost of goods sold; this means that the gross
margin does not necessarily reflect a proper matching of revenues and costs. For example,
in an inflationary environment, current-cost revenue dollars will be matched against older
and lower-cost inventory items, which yields the highest possible gross margin.
The FIFO method is allowed under both Generally Accepted Accounting Principles and
International Financial Reporting Standards. The FIFO method provides the same results
under either the periodic or perpetual inventory system.
Example of the First-in, First-out Method
Milagro Corporation decides to use the FIFO method for the month of January. During that
month, it records the following transactions:
Quantity
Change
Actual
Unit Cost
Actual
Total Cost
+100 $210 $21,000
Sale -75
Purchase (layer 2) +150 280 42,000
Sale -100
Purchase (layer 3) +50 300 15,000
Ending inventory = 125
The cost of goods sold in units is calculated as:
100 Beginning inventory + 200 Purchased – 125 Ending inventory = 175 Units
Milagro’s controller uses the information in the preceding table to calculate the cost of goods
sold for January, as well as the cost of the inventory balance as of the end of January.
Units Unit Cost Total Cost
FIFO Method - AccountingTools
http://www.accountingtools.com/fifo-method[3/29/2015 11:40:23 AM]
Cost of goods sold
FIFO layer 1 100 $210 $21,000
FIFO layer 2 75 280 21,000
175 $42,000
Ending inventory
FIFO layer 2 75 280 $21,000
FIFO layer 3 50 300 15,000
125 $36,000
Thus, the first FIFO layer, which was the beginning inventory layer, is completely used up
during the month, as well as half of Layer 2, leaving half of Layer 2 and all of Layer 3 to be
the sole components of the ending inventory.
Note that the $42,000 cost of goods sold and $36,000 ending inventory equals the $78,000
combined total of beginning inventory and purchases during the month.
Related Topics
FIFO vs. LIFO accounting
Last-in first-out method
Specific identification method
Weighted average method
What are perpetual LIFO and periodic LIFO?
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