First In First Out (FIFO) Method

First In First Out (FIFO) is one of widely known methods of cost assignment to determine the cost of units sold (cost of sales) and value of inventory still at hand by the period end.



FIFO assumes that entity use or consume units in the same order as they are purchased or produced i.e. the oldest goods purchased or produced are sold or consumed first and it is the newest goods that remains in the warehouse by the end of the end of the period.

The implication of FIFO assumption is that cost of goods sold includes the cost of oldest units purchased or produced whereas the value of period end inventory is based on the cost of newest units. In other words the value of closing inventory is considered to be better reflection of most recent market prices.

Getting in more details, with FIFO assumption in place:

  • in period of rising prices the cost assigned to period end inventory will be higher than the cost assigned to units sold or consumed; whereas
  • in period of falling prices the cost assigned to period end inventory will be lesser than the cost assigned to units sold or consumed.

1 FIFO under different inventory systems

We learnt that management may choose to record changes in inventory on periodic basis (intervals) or perpetual basis (regular). Though there are differences between periodic and perpetual inventory systems but under FIFO both systems will render same result. The reasons is that oldest costs are accounted for as cost of sales and latest cost is used to value inventory and recording is also done in the same fashion the oldest is recorded first and latest is recorded last. Lets understand this with an example

Example: FIFO under Periodic and Perpetual inventory systems

For the month ended details of inventory related transaction is provided.

1-Jul
3-Jul
7-Jul
15-Jul
18-Jul
22-Jul
25-Jul
28-Jul
31-Jul
Starting inventory
Purchases
Purchases
Sales
Purchases
Sales
Sales
Purchases
Sales
76 units @ $10/unit
150 units @ $12/unit
50 units @ $11/unit
100 units
80 units @ $15/unit
120 units
10 units
200 units @ $14/unit
67 units

Calculate the Cost of Sales and Ending inventory value using FIFO method under:

(a) Periodic system
(b) Perpetual system

Solution:

(a) FIFO Inventory valuation under Periodic system

Calculation of Units available for Sale:

DateTransactionUnitsRateTotal
1-Jul
3-Jul
7-Jul
18-Jul
28-Jul
Opening inventory
Purchases
Purchases
Purchases
Purchases
76
150
50
80
200
10
12
11
15
14
760
1800
550
1200
2800
5567110

Physical count of inventory:

As we cannot count the inventory here so we are assuming it be same as we expect after all the transactions of purchases and sales and we can calculate the units:

= Units available for sale – Sales = Ending inventory
= 556 – (100+120+10+67)
= 556 – 297
= 259

Under FIFO method, our ending inventory will be from the latest purchases i.e. purchases of July 28 and 18 and thus valued as follows:

200 units
59 units
@ $14/unit (rate of July 28)
@ $15/unit (rate of July 18)
=
=
2800
885
259 units3685

Calculate of Cost of Goods sold:

Now that we know goods available for sale and ending inventory we can calculate cost of goods sold.

UnitsCost
Available for Sale
Less: Ending Inventory
556
(259)
7110
(3685)
Goods sold2973425

(b) FIFO Inventory valuation under Perpetual system

Under perpetual system all changes inventory are recorded as they happen, therefore we have a chronological record of all the transactions and at the end of the period we automatically get the cost of goods sold and value of ending inventory.

DatePurchasesSalesBalance
JulyQty.RateTotalQty.RateTotalQty.RateTotal
17610760
315012180076
150
10
12
760
1800
7501155076
150
50
10
12
11
760
1800
550
1576
24
10
12
760
288
126
50
12
11
1512
550
1880151200126
50
80
12
11
15
1512
550
1200
221201214406
50
80
12
11
15
72
550
1200
256
4
12
11
72
44
46
80
11
15
506
1200
2820014280046
80
200
11
15
14
506
1200
2800
3146
21
11
15
506
315
59
200
15
14
885
2800
2973425

The total of units sold and their related cost is same as we calculated under periodic system above. Also the value of ending inventory is same. Hence, it confirms that choice of inventory system does not affect valuation of CGS and ending inventory under FIFO method.