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:
Date | Transaction | Units | Rate | Total |
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 |
556 | 7110 |
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 units | 3685 |
Calculate of Cost of Goods sold:
Now that we know goods available for sale and ending inventory we can calculate cost of goods sold.
Units | Cost | |
Available for Sale Less: Ending Inventory | 556 (259) | 7110 (3685) |
Goods sold | 297 | 3425 |
(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.
Date | Purchases | Sales | Balance | ||||||
---|---|---|---|---|---|---|---|---|---|
July | Qty. | Rate | Total | Qty. | Rate | Total | Qty. | Rate | Total |
1 | 76 | 10 | 760 | ||||||
3 | 150 | 12 | 1800 | 76 150 | 10 12 | 760 1800 |
|||
7 | 50 | 11 | 550 | 76 150 50 | 10 12 11 | 760 1800 550 |
|||
15 | 76 24 | 10 12 | 760 288 | 126 50 | 12 11 | 1512 550 |
|||
18 | 80 | 15 | 1200 | 126 50 80 | 12 11 15 | 1512 550 1200 |
|||
22 | 120 | 12 | 1440 | 6 50 80 | 12 11 15 | 72 550 1200 |
|||
25 | 6 4 | 12 11 | 72 44 | 46 80 | 11 15 | 506 1200 |
|||
28 | 200 | 14 | 2800 | 46 80 200 | 11 15 14 | 506 1200 2800 |
|||
31 | 46 21 | 11 15 | 506 315 | 59 200 | 15 14 | 885 2800 |
|||
297 | 3425 |
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.