First In First Out (FIFO)
What is FIFO?
FIFO, or “First In, First Out”, is a process some businesses use to calculate their inventory that relies on assumptions about cost flow. The FIFO method adheres to removing or selling the oldest pieces of inventory first. Therefore, the income statement of a business using FIFO will display/list the cost of its oldest inventory first. This ensures that at the end of the sales period, the most recently purchased inventory items are available.
Even if additional inventory is later purchased at a higher price, the cost per unit to be recorded on the income statement remains at the original price point until the number of units purchased at that price have been sold.
How FIFO works
A business purchases 50 units for $5.
One week later, it purchases an additional 100 units for $7.
Two weeks later, it purchases an additional 50 units for $10.
At the end of the month, the business sells 150 units.
Using FIFO, it’s assumed that:
The first 50 of the 150 units sold cost $5.
The following 100 units sold cost $7.
The next units to be up for sale will cost $10, even if more of the same inventory is purchased before they’ve all sold out. That’s because the $10 units are now the oldest inventory.
You may also be interested in:
Why would a company use FIFO?
The FIFO method is one of many inventory management and calculation methods, but it also insists that the inventory stays fresh to avoid holding on to out-of-date items.
The use of FIFO can be applied in different contexts. For some businesses, the method is required. A cafe that purchases milk for lattes will need to use the milk purchased first to avoid product spoilage, otherwise it’s literal money down the drain.
What is the difference between FIFO and LIFO?
With FIFO, the first items that come into the inventory are the first to be sold, where the LIFO method is the opposite: The latest inventory purchased is the first to be sold.