Glossary term
First In, First Out (FIFO)
First in, first out is an inventory accounting method that treats the oldest inventory costs as sold first for cost-of-goods-sold purposes.
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What Is First In, First Out?
First in, first out, or FIFO, is an inventory accounting method that treats the oldest inventory costs as sold first for cost-of-goods-sold purposes. It is a cost-flow assumption used to calculate inventory and gross profit.
FIFO often resembles the physical flow of perishable goods, but it is not limited to perishable inventory. The accounting method can affect reported income, taxes, and balance-sheet inventory values when costs change over time.
Key Takeaways
- FIFO assumes the oldest inventory costs flow into cost of goods sold first.
- Ending inventory is based on newer inventory costs.
- During rising costs, FIFO often reports higher profit than LIFO.
- FIFO can make ending inventory values closer to current replacement costs.
- The method affects gross margin, taxes, and financial statement comparisons.
How FIFO Works
Suppose a business buys 100 units at $10 and later buys 100 units at $12. If it sells 100 units under FIFO, cost of goods sold is based on the earlier $10 cost. The newer $12 layer remains in ending inventory.
When costs are rising, that usually means lower cost of goods sold and higher gross profit than LIFO. When costs are falling, FIFO can produce the opposite effect.
FIFO Compared With LIFO
Method | Cost assigned to goods sold first | Common effect when costs rise |
|---|---|---|
FIFO | Oldest inventory costs | Lower cost of goods sold and higher reported profit |
LIFO | Newest inventory costs | Higher cost of goods sold and lower taxable income |
What Businesses Should Watch
FIFO can be easier to understand because it follows the idea that older goods are sold first. It can also make ending inventory values more current in periods of rising prices because the newest costs remain on the balance sheet.
The tradeoff is that taxable income may be higher when costs are rising because older, lower costs are matched against current sales. Businesses should evaluate the method's effect on margins, tax planning, lender reporting, and inventory controls.
The Bottom Line
FIFO is an inventory cost-flow method that treats the oldest costs as sold first. It can make inventory values more current, but it can also increase reported profit and tax exposure during periods of rising inventory costs.