FIFO Method (First In First Out)

FIFO Method (First In First Out)

FIFO Method (First In First Out)

The FIFO technique is distinguished in that the oldest purchase costs are transferred to the cost of products sold, while the most recent costs remain in inventory.

We have lived in an inflationary economy for the previous 50 years, which implies that most prices have risen over time. When purchase costs rise, the FIFO approach assigns lower (older) costs to the cost of goods sold and higher (newer) costs to products remaining in inventory.

By allocating lower costs to the cost of goods sold, FIFO often causes a firm to record somewhat larger profits than would be reported under the other inventory valuation techniques. Some businesses use the FIFO approach for financial reporting purposes because they want to report the biggest net income possible.However, for income tax reasons, declaring more income than necessary leads in paying more taxes than necessary.

Some accountants and business executives believe that FIFO overstates a company’s profitability. Revenue is determined by current market circumstances. By balancing this income with a cost of goods sold based on previous (and lower) pricing, total profits may be continually overestimated.

The FIFO method has the conceptual benefit of valuing inventory at its most recent purchase cost. Therefore, this asset shows on the balance sheet at a value that is similar to its current replacement cost.

Characteristics of FIFO

  • This is a popular approach for calculating the cost of goods sold and closing stock.
  • The FIFO technique transfers the oldest available purchasing expenses to the cost of items sold. That implies the cost of goods sold will be cheaper, and the organization’s profitability will increase.
  • Because the current stock is valued at the most recent highest prices, the company’s current assets have the most recent evaluated values.

Example:

ABC & Co. is a manufacturing firm. The following is the record of receipts and issues for the month of January 2020.

DateReceiptsIssues
Jan 7200 Units @ $50/unit
Jan 960 units
Jan 13150 Units @ $75/unit
Jan 18100 Units @ $60/unit
Jan 22150 units
Jan 24100 units
Jan 28100 Units @ $50/unit
Jan 31200 units

Calculate the value of the closing stock by FIFO method

Solution:

Valuation of Stock by FIFO Method

FIFO

We also have:

What is Inventory Valuation

What is Inventory in Accounting

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