The first-in, first-out (FIFO) inventory method is a method for valuing inventory which assumes that the oldest purchases are the first units sold.
The FIFO method is one of three inventory valuation methods, the other two being the last-in, last-out method (LIFO) and the weighted-average inventory method.
The FIFO and LIFO methods are referred to as inventory flow assumptions. The actual flow of inventory need not correspond with the assumed inventory flow under the FIFO or LIFO methods.
For an example of FIFO accounting, consider a retailer that has 30 units in inventory at the beginning of January valued at $4 per unit. In the month of January, the retailer makes the following purchases (the exact item is irrelevant): 100 units on January 1st at $5 per unit; 100 units on January 10th at $5.20 per unit; 100 units on January 20th at $5.10 per unit. Suppose that in the month of January, the company sells 250 units. To calculate January’s cost of goods sold, the retailer assumes the sales are made in the following order. First, the 30 units in inventory at $4 per unit. Second, the 100 units purchased on January 1st at $5 per unit. Third, the 100 units purchased on January 10th at $5.20 per unit. And fourth, 20 units from the units purchased on January 20th at $5.10 per unit. The total cost of goods in January for this item is $1,242. The items in inventory at the end of January are the remaining 80 units from the January 20th purchase at $5.10 per unit. The remaining inventory is thus $408.
When prices are rising, FIFO tends to understate cost of goods sold, but provides a more accurate value for remaining inventory.
