FIFO Method Of Inventory Valuation

FIFO Method Of Inventory Valuation

When looking for positions in inventory or asset management, you may notice that employers are looking for applicants who are familiar with the FIFO method of inventory valuation. Even if you have no firsthand experience with the FIFO method, you may gain a thorough understanding of it and speak eloquently about it.

This article will explain the FIFO method of inventory management and how it differs from other types of inventory valuation systems to help you gain that understanding.

What is FIFO Method of Inventory Valuation?

The inventory costing method of First In, First Out (FIFO) assumes that the costs of the first goods purchased are the costs of the first goods sold. The notion that FIFO follows in terms of cost flow is clearly expressed in its name. FIFO assumes that the first cost received in stores is also the first cost that leaves the stores.

If your company makes passenger vehicle engines and employs the FIFO method of inventory management, for example, your accounting system expects that the motors made last month would be shipped to buyers before the ones made lately. When it comes time to count inventory at the end of the year, FIFO assumes that what is on hand consists of the most recently manufactured goods in inventory.

Put differently, under FIFO method, the cost of materials is charged to production in the order in which they are purchased. For costing requisitions, earlier costs recorded in materials ledger cards are used, and the balance is made up of units received later.

FIFO Method of Costing: Explanation

The FIFO method of costing is on the basis of the assumption that different lots of materials are bought in the same order they are received. That is, under this method of costing, materials are issued from the oldest supply in stock.

The cost of materials used in a work or process is deducted from the total cost of the job or process. This is why the FIFO approach is also known as the original pricing method.

Excess materials returned to the storeroom after being provided to the manufacturer for a specific job are treated as the oldest stock on hand. It's put on the materials card balance ahead of all the other units on hand, at the same price it was given to the factory.

Advantages of FIFO Method

The following are the key benefits of the FIFO method of costing:

  1. Since no difficult calculations are required, it is simple to use.
  2. Materials are selected in a legal order from the cost record.
  3. In the order of receipt, materials are charged to production at their true cost.
  4. Closing inventory is valued at a price that is closer to the current market price.
  5. When the size and cost of material units are big, this is beneficial.

Disadvantages of FIFO Method

The FIFO method of costing has the following disadvantages or drawbacks:

  1. The material cost charged to production may or may not represent current market prices.
  2. When multiple purchases of the same material are made at various prices, keeping track of them can be challenging.
  3. When returning items to merchants, costing issues develop.
  4. When extra supplies are returned from the factory to the warehouse, costing issues develop.

Example of FIFO Method

Consider the following:

  1. April 01: Inventories on hand are 50 units at $2 and 100 units at $4.50
  2. April 05: Purchased 100 units at $1.80
  3. April 06: 10 units of inventories purchased on 5 April at $1.80 are returned to supplier
  4. April 10: 80 units issued to factory
  5. April 15: 50 units issued to factory
  6. April 20: 20 units purchased at $1.50
  7. April 25: 70 units issued to factory
  8. April 30: 50 units purchased at $1.70
  9. April 30: 10 units returned to store out of units issued to factory on 25 April

Required: Use the FIFO method to show the value of the stock on hand.

FIFO Method Of Inventory Valuation

How Is FIFO Different From Other Methods Of Inventory Valuation?

The LIFO method of accounting is the most popular alternative to the FIFO system. LIFO is the acronym for Last In, First Out. This strategy assumes that the most recent products added to the inventory will be the first to be sold. Continuing with the previous scenario, the value of your inventory would be determined by the cost of producing the engines you created yesterday vs the cost of building the ones you made a month ago.

The average cost inventory method is an alternative to the FIFO or LIFO approaches. The average cost is calculated using this approach, which divides the cost of producing all of the goods in the current inventory by the number of items available for sale. After then, this cost is applied to all items. The average cost inventory approach strikes a balance between FIFO and LIFO in terms of accuracy.

Another method of inventory valuation is specific inventory tracing. A business must know the cost of all the components that go into a final product in order to use it. This data enables the company to keep track of the exact cost of producing a certain item, which is a more difficult procedure. If you don't have all of that data, you should use FIFO, LIFO, or the average cost inventory method.

Specific inventory tracing is yet another method of inventory valuation. For a company to use this method, it must know the cost of all the components that go into a finished product. That information allows the company to keep track of the precise cost to produce a specific item, which is a more complicated process. If you don't have all of that information, then FIFO, LIFO or the average cost inventory method is a better choice.

Why Would You Use FIFO over LIFO?

When calculating cost of goods sold in the United States, a company can use either the FIFO ("First-In, First-Out") or LIFO ("Last-In, First-Out") method. Both are legal, yet the LIFO approach is frequently criticized since bookkeeping is significantly more complicated and accountants & bookkeepers can easily manipulate the method.

Since the LIFO method allows a corporation to use its most recent product costs first, corporate taxes are less expensive. These prices have typically increased over time. Reduced profits may result in tax breaks, but they may also make a company less appealing to investors.

FIFO is popular among investors and financial institutions because it is a clear method of determining cost of goods sold. Due to its simplicity, it is also easier for management to keep track of bookkeeping and finances. It also means that the company will be able to declare a higher profit, which will make the company more appealing to potential investors. Finally, a more precise amount for remaining inventory can be stated.


Many countries outside of the United States, including Canada, India, and Russia, are obligated to adopt the IFRS (International Financial Reporting Standards) Foundation's guidelines. The International Financial Reporting Standards (IFRS) establish a foundation for globally accepted accounting standards, including the requirement that all company use the FIFO method to compute cost of goods sold. As a result, many businesses, including those in the United States, have adopted FIFO as a policy.
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