FIFO is an acronym that stands for “First In, First Out”. It is a method of inventory management that assumes that the first items received into inventory are the first items sold or used. This method is commonly used in accounting and warehousing to track inventory and calculate its value. FIFO assumes a steady flow of both purchases (inflows) and sales (outflows) of inventory. The primary entities associated with FIFO include: inventory, accounting, warehousing, and supply chain management.
What Does FIFO Refer To?
FIFO (First In, First Out) is a common method used in inventory management to track the movement of goods. It assumes that the oldest inventory items are the first to be sold or used, regardless of when they were purchased or received.
How FIFO Works
- Goods purchased first: are recorded in the inventory system as the first available for sale or use.
- When inventory is sold/used: The cost of the oldest inventory items (i.e., those purchased first) is recognized as the cost of goods sold (COGS).
- This process continues: As new inventory is purchased, it is added to the end of the inventory list, and the oldest items are continually sold/used first.
Benefits of FIFO
- Accurate Cost of Goods Sold: FIFO aligns the cost of goods sold with the actual cost of the inventory items sold, providing a more accurate representation of the company’s financial performance.
- Simpler Inventory Management: FIFO simplifies inventory tracking by assuming that the oldest items are always the first to go, eliminating the need for complex tracking systems.
- Lower COGS in periods of falling prices: When prices are falling, FIFO results in a lower cost of goods sold compared to other inventory methods (e.g., LIFO).
Disadvantages of FIFO
- Higher COGS in periods of rising prices: In periods of rising prices, FIFO can result in a higher cost of goods sold compared to other inventory methods (e.g., LIFO).
- May not reflect actual inventory flow: FIFO assumes a perfect inventory flow, which may not always be the case in practice.
- Tax implications: FIFO can have different tax implications depending on tax laws and regulations in specific countries.
FIFO in Practice
FIFO can be implemented using a variety of methods, including:
- Periodic FIFO: The cost of goods sold is calculated at the end of each accounting period by determining the cost of the oldest inventory items on hand.
- Perpetual FIFO: The cost of goods sold is tracked on an ongoing basis as inventory is sold/used.
- Specific Identification: Each inventory item is tracked individually, and the cost of specific items sold/used is used to determine the cost of goods sold.
Table Summary
| Inventory Method | Cost of Goods Sold | Benefits | Disadvantages |
|---|---|---|---|
| FIFO | First in, first out | Accurate COGS | Higher COGS in rising prices |
| LIFO | Last in, first out | Lower COGS in rising prices | Higher COGS in falling prices |
| Average Cost | Weighted average of inventory costs | Stable COGS | Can distort COGS in periods of significant price changes |
Question 1:
What is the full form of FIFO?
Answer:
FIFO stands for First-In, First-Out.
Question 2:
Define FIFO method.
Answer:
In the FIFO method, the oldest inventory items are sold or used first.
Question 3:
How is FIFO used to determine cost of goods sold?
Answer:
FIFO assumes that the cost of goods sold is equal to the cost of the oldest inventory items.
Well, there you have it! Now you know what FIFO stands for and how it works. Thanks for sticking with me through this journey. If you’re looking to learn more about inventory management or other business topics, be sure to check out our other articles. We’ve got a ton of helpful information that can help you take your business to the next level. In the meantime, keep your inventory flowing smoothly and don’t forget the importance of FIFO!