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 stock at the end of the period. This will allow a business to determine the cost of goods sold and the value of the closing 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. The inventory purchased first (in) is sold first (out).
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 opening stock
- 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 opening inventory)
- 100 units are sold with a cost of 5.50 (all opening 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 closing inventory with a cost of 300 x 5.50 = 1,650
The FIFO method used in this example is demonstrated in the tables below.
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 opening inventory has all been sold, the remaining closing inventory is all 5.50 units.
|Units @ 5.00||Units @ 5.50||Total Units|
|Additions to inventory||400||400|
|Sales of inventory||– 100||– 100||– 200|
This table converts the units in the table above to values at either 5.00 or 5.50 per unit.
|Value of Units @ 5.00||Value of Units @ 5.50||Total Value|
|Additions to inventory||2,200||2,200|
|Sales of inventory||– 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 closing inventory determines the value of the cost of goods sold and the closing inventory. As profit depends on the cost of goods sold, the method chosen will affect the profits of a business.