What is FIFO (First In, First Out)?
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First In, First Out (FIFO) Definition
“FIFO,” or First In, First Out, is a method of inventory accounting which expenses the first inventory received prior to later inventory when calculating the cost of goods sold.
This inventory accounting method stands in contrast with “LIFO” or “Last In, First Out” and “WAC” or “Weighted Average Cost” methods.
Example of First In, First Out
FIFO Justice buys 3 sets of 1,000 wristbands fighting for justice for $1.70 each, then $1.30 each, then $2.00 each.
FIFO Justice determines it has sold 2,000 units for the period.
When calculating their cost of goods sold under FIFO, the 2,000 wristbands bought for $1.70 each and $1.30 each will be included, but not the 1,000 wristbands for $2.00 each.
Their cost of goods sold for the period is therefore $3,000.
In periods of falling inventory costs, a company using FIFO will have a lower gross profit because their cost of goods sold is based on older, more expensive inventory.
In periods of rising costs, that company will have a greater gross profit because their cost of goods sold is based on older, cheaper inventory.
The Purpose of FIFO
The goal of any inventory accounting method is to represent the physical flow of inventory.
FIFO is the most commonly used inventory accounting method because most companies sell older inventory first, like in the case of milk at a grocery store.
It is the preferred method for US Financial Reporting and is the only acceptable method in International Financial Reporting.