KTA Manufacturing Technology

What is FIFO? 🤔

FIFO (First-In, First-Out) is an inventory valuation method in which the goods that are purchased or produced first are assumed to be sold or issued first.

In other words, the inventory that enters first is sold or issued before the newer inventory.

How FIFO Works

Under FIFO:

The Cost of Goods Sold (COGS) is based on the cost of the inventory purchased first.

The Ending Inventory is valued using the costs of the inventory purchased later.

The FIFO method follows the chronological order of inventory purchases.

Example of FIFO Calculation

Inventory Data

DateUnitsCost per UnitJan. 1100 unitsBr. 10Jan. 10200 unitsBr. 12Jan. 20150 unitsBr. 14

Total units available for sale = 450 units

Let us assume that 300 units are sold.

Cost of Goods Sold (COGS) Under FIFO

The first 300 units are sold first:

100 units × Br. 10 = Br. 1,000

200 units × Br. 12 = Br. 2,400

COGS = Br. 3,400

Ending Inventory

Units remaining:

450 − 300 = 150 units

These are the most recently purchased units:

150 units × Br. 14 = Br. 2,100

Therefore:

Ending Inventory = Br. 2,100

Effect of FIFO When Prices Are Increasing

When the cost of goods is continuously increasing:

COGS → Lower

Gross Profit → Higher

Ending Inventory → Higher

Tax Expense → Higher

When the Cost of Goods Is Decreasing

When the cost of goods is decreasing:

COGS → Higher

Gross Profit → Lower

Ending Inventory → Lower

Advantages of FIFO

It is easy to understand and apply.

Ending inventory generally reflects more recent purchase costs.

It is permitted under IFRS and is widely used in accounting.

It is suitable for goods whose useful life or shelf life is short, such as perishable products.

Disadvantages of FIFO

During periods of high inflation, it can result in higher reported profits and higher taxes.

If older inventory costs are much lower than current costs, FIFO can overstate the reported profit.

It may not be ideal when prices change significantly or frequently.