First In, First Out (FIFO): Definition
First in, first out (FIFO) is an inventory costing method that assumes the costs of the first goods purchased are the costs of the first goods sold.
In terms of flow of cost, the principle that FIFO follows is clearly reflected in its name. Specifically, FIFO assumes that the first cost received in stores is the first cost that goes out from the stores.
In other words, under FIFO, the cost of materials is charged to production in the order of purchases. Earlier costs recorded in materials ledger cards are used for costing requisitions, and the balance consists of units received later.
FIFO Method of Costing: Explanation
The FIFO method of costing is based on the assumption that the various lots of materials that are purchased are used in the same order in which they are received. That is to say, the materials are issued from the oldest supply in stock in this method of costing.
The materials used in a job or process are charged at the price of their original purchase. This is why FIFO is often referred to as the original price method.
The return of excess materials, initially issued to the factory for a particular job, to the storeroom is treated as the oldest stock on hand. It is placed on the materials card balance ahead of all the units on hand at the same price as it was issued to the factory.
Advantages of FIFO Method of Costing
The following are the main advantages of the FIFO method of costing:
- Simple to operate because no complex calculations are involved
- Materials used are drawn from the cost record in a legal order
- Materials issued are charged to production at actual cost in the order of their receipt
- Valuation of closing inventory is closer to current market price
- Beneficial whenever the size and cost of material units are large
Disadvantages of FIFO Method of Costing
The following are the disadvantages and drawbacks of the FIFO method of costing:
- The cost of material charged to production may not reflect the current market price
- Record-keeping may be difficult if several purchases of the same material are made at different prices
- Costing difficulties arise when returning items to vendors
- Costing difficulties arise when excess materials are returned from the factory to the storeroom
Consider the following:
- April 01: Inventories on hand are 50 units at $2 and 100 units at $4.50
- April 05: Purchased 100 units at $1.80
- April 06: 10 units of inventories purchased on 5 April at $1.80 are returned to the supplier
- April 10: 80 units issued to factory
- April 15: 50 units issued to factory
- April 20: 20 units purchased at $1.50
- April 25: 70 units issued to factory
- April 30: 50 units purchased at $1.70
- April 30: 10 units returned to store out of units issued to the factory on 25 April
Required: Shows the value of the stock on hand using the FIFO method.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.