What is the FIFO method?
The FIFO method (First In First Out) is a way of determining which items of inventory have been sold during a period and which items remain in inventory at the end of the period. This will allow a business to determine the cost of goods sold and the value of the ending inventory. A method is needed because all items are not purchased at the same price.
The FIFO method assumes that the goods are used in the order in which they were put into inventory. It should be noted that it is not necessary for the business to physically use the goods in this order only to value it based on that assumption.
FIFO Method Example
By way of illustration.
If a business had the following inventory information for October:
October 1 Beginning inventory 100 units 5.00 cost per unit
October 4 Purchased 400 units 5.50 cost per unit
October 10 Sold 200 units
Under the FIFO method the following happens:
- 100 units are added at 5.00 as beginning inventory
- 400 units are added at 5.50 as purchases
- 100 units are sold at with a cost of 5.00 (first units sold are those in beginning inventory)
- 100 units are sold with a cost of 5.50 (all beginning inventory has been used, so some of the purchases at 5.50 are now sold)
The cost of the goods sold would be given by 100 x 5.00 + 100 x 5.50 = 1,050. After the items have been sold 300 units (100 + 400 – 100 – 100) remain in ending inventory with a cost of 300 x 5.50 = 1,650
The FIFO method used in this example is demonstrated in the tables below.
FIFO Method Showing Units
The first table shows the movement in units. The items sold comprise 100 of the 5.00 units and 100 of the 5.50 units. It also shows that because the beginning inventory has all been sold, the remaining ending inventory is all 5.50 units.
|Units 5.00||Units 5.50||Total|
|Sales||– 100||– 100||– 200|
FIFO Method Showing Value
This table converts the units in the table above to values at either 5.00 or 5.50 per unit.
|Value 5.00||Value 5.50||Total|
|Sales||– 500||– 550||– 1,050|
The FIFO method is one of the available methods used in inventory management. Clearly the method used to determine which units are sold and which remain in ending inventory determines the value of the cost of goods sold and the ending inventory. As profit depends on the cost of goods sold, the method chosen will affect the profits of a business.