FIFO: First In First Out Inventory Management Explained

Rachel is a Content Marketing Specialist at ShipBob, where she writes blog articles, eGuides, and other resources to help small business owners master their logistics. Yes, ShipBob’s lot tracking system is designed to always ship lot items with the closest expiration date and separate out items of the same SKU with a different lot number. ShipBob is able to identify inventory locations that contain items with an expiry date first and always ship the nearest expiring lot date first.

FIFO and LIFO Inventory Management and Calculations

Suppose the number of units from the most recent purchase been lower, say 20 units. We will then have to value 20 units of ending inventory on $4 per unit (most recent purchase cost) and the remaining 3 units on the cost of the second most recent purchase (i.e., $5 per unit). Therefore, the value of ending inventory is $92 (23 units x $4), which is the same amount we calculated using the perpetual method. Now that we have ending inventory units, we need to place a value based on the FIFO rule. To do that, we need to see the cost of the most recent purchase (i.e., 3 January), which is $4 per unit. Here’s a summary of the purchases and sales from the first example, which we will use to calculate the ending inventory value using the FIFO periodic system.

Calculating Cost Using First-In, First-Out (FIFO Method)

If we take 100 units out of inventory, we would take them from beginning inventory. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided. Statements are more transparent and it’s more difficult to manipulate FIFO-based accounts to embellish the company’s financials. FIFO is required under the International Financial Reporting Standards and it’s also standard in many other jurisdictions.

How much do you know about inventory costing methods?

Though some products are more vulnerable to fluctuating price changes, dealing with inflation when restocking inventory is inevitable. It is the amount by which a company’s taxable income has been deferred by using the LIFO method. Let’s say you’ve sold 15 items, and you have 10 new items in stock and 10 older items. You would multiply the first 10 by the cost of your newest goods, and the remaining 5 by the cost of your older items to calculate your Cost of Goods Sold using LIFO. To calculate the Cost of Goods Sold (COGS) using the LIFO method, determine the cost of your most recent inventory.

If you want to have an accurate figure about your inventory then FIFO is the better method. For tax reasons, FIFO assumes that assets with the oldest costs are included in the cost of the goods sold in the income statement (COGS). The remaining inventory assets match the assets most recently purchased or manufactured. Every business must adhere to Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) when choosing FIFO or LIFO. FIFO or LIFO can have a big impact on your business’s financials and tax.

How does the FIFO method affect taxable profits?

It is an alternative valuation method and is only legally used by US-based businesses. For example, if you sold 15 units, you would multiply that amount by the cost of your oldest inventory. Using the FIFO inventory method, this would give you your Cost of Goods Sold for those 15 units.

When you want to select between FIFO and LIFO inventory valuation methods, you must consider the current inventory valuation you use, inflation, financial reporting, and taxes. The remaining inventory would then consist of 2,000 units from the second batch at $1.75 each, totaling $3,500. This method ensures that the ending inventory reflects the most recent market prices, providing a more accurate picture of the company’s inventory cost and financial health. If you sell 120 units, the cost of goods sold is calculated using the recent $20 units first, followed by the remaining units from the previous batch. If you’re looking for an alternative method to value your inventory, the Average Cost approach is another solution.

The average cost is found by dividing the total cost of inventory by the total count of inventory. Bertie also wants to know the value of her remaining inventory—she Accounting For Architects wants her balance sheet to be accurate. The oldest bars in her inventory were from batch 1 so she will count 100 at the unit cost of batch 1, $2.00. For the remaining 200 she sold uses the unit cost of batch 2, $1.00. To calculate her COGS for the trade show, Bertie will count 100 bars at $2.00 and 200 at $1.50. Under FIFO, your Cost of Goods Sold (COGS) will be calculated using the unit cost of the oldest inventory first.

May Not Reflect Inventory Flow

In inflation, LIFO will give you higher COGS and thus lower profits as it uses newer, higher-cost inventory to calculate COGS. This will give you lower taxable income and impact your overall financial health by reducing the tax bill. This is especially good for businesses that deal with perishable goods where inventory turnover is fast, and profitability is key. This is used for cost flow assumption purposes, the method in which costs are removed from a business’s inventory and reported as the cost of sold products. FIFO is an assumption because the flow of costs of an inventory doesn’t have to match the actual flow of items out of inventory. FIFO is an inventory management method that follows the principle of “first in, first out.” As mentioned, this means that the oldest products in a warehouse are the first to be sold or used.

How the FIFO Method Works

In the last 10 years, she has worked with clients all over the country and now sees her diagnosis as an opportunity that opened doors to a fulfilling life. Kristin is also the creator of Accounting In Focus, a website for students taking accounting courses. Since 2014, she has helped over one million students succeed in their accounting classes. If we add the cost of goods sold and ending inventory, we get $3,394.00 which is our goods available for sale.

That would leave 50 units from beginning inventory and 75 from the purchase on January 3rd. Update the list of goods available for sale to reflect what was sold and the additional purchase on January 12. The wonderful thing about FIFO is that the calculations are the same for both periodic and perpetual inventory systems because we are always taking the cost for the oldest units. To calculate the cost of goods sold, you take the number of shirts you sold at each price and multiply by that price. To calculate FIFO and the total cost of goods sold, multiply the cost of the item by how many items you’ve either bought or sold at that price. Some companies choose the LIFO method because the lower net income typically leads to lower income taxes.

• The oldest bars in her inventory were from batch 1 so she will count 100 at the unit cost of batch 1, $2.00.
• Going by the FIFO method, Sal needs to go by the older costs (of acquiring his inventory) first.
• Using FIFO could show the company’s natural profitability which if it may be high then it would attract the shareholders to invest in that company.
• Later on, you purchase another 80 units – but by then, the price per unit has risen to $6, so you pay $480 to acquire the second batch.
• It’s also an accurate system for ensuring that inventory value reflects the market value of products.
• On the other hand, Periodic inventory systems are used to reverse engineer the value of ending inventory.

This means lower COGS and higher gross income, which often means higher taxable income. The cost of goods sold (COGS) is calculated as a sum of beginning inventory (opening inventory), purchases during the period, and closing (ending) inventory. FIFO (First In, First Out) assumes that the oldest inventory items are sold first, while LIFO (Last In, First Out) assumes the newest inventory items are sold first. This fundamental difference in inventory flow shapes the financial outcomes and operational strategies of your company.