FIFO – What is FIFO?
FIFO is a method of stock valuation that stands for ‘First-In, First-Out’. This assumes that the first (oldest) units of stock produced or received are also the first ones that are sold
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The FIFO method is an important means for a company to value their ending inventory at the finish of an accounting period. This amount can help businesses determine their Cost of Goods Sold, an important number for budgets and evaluating profitability.
First in, First out
Under the FIFO method of stock management a company assumes that the oldest items in stock are the ones being sold first – regardless of which units are actually sold first.
This way, if the price of production or the wholesale purchase cost of these items was different than the current price, you will account for these goods at the oldest value – not the current one. FIFO is the opposite of the LIFO valuation method, which conversely assumes that the most recent cost of stock should be recorded ‘Last-In, First-Out’.
Why stock valuation matters
The FIFO and LIFO Methods are accounting techniques used in managing a company’s stock and financial matters. They help a company determine the value of their stock, raw materials, etc. They are used to manage cost flows assumptions related to stock and stock repurchases (if purchased at different prices).
Because FIFO is also useful in working out the value of a company’s ending inventory,
FIFO vs. LIFO example
To outline the difference between FIFO and LIFO, let’s use the example of a company that produces colourful socks.
Let’s say that this company produces 500 pairs of socks on Monday at a cost of £3 each, and 500 more on Tuesday at £3.25 each. Now they have 1,000 pairs of socks in stock worth £3,125.00.
FIFO states that if the company then sold 500 pairs of socks on Wednesday, their cost of goods sold for those 500 pairs is £3 per pair, or £1,500 (recorded on the income statement). This is because this was the cost of each of the first pairs of socks in their stock.
The remaining 500 pairs would then be allocated to the company’s ending stock at £3.25 each (recorded on the balance sheet), resulting in an ending stock balance of £1,625.00.
LIFO states that if the company then sold 500 pairs of socks on Wednesday, their cost of goods sold for those 500 pairs is £3.25 per pair, or £1,625.00 (recorded on the income statement). This is because £1.25 was the cost of each of the last pairs in their stock.
The remaining 500 pairs would then be allocated to the company’s ending stock at £3.00 each (recorded on the balance sheet), resulting in an ending stock balance of £1,500.00.
The LIFO method is in fact banned now in the US, and has never been a part of the stock management activities of businesses in the UK. FIFO or average cost valuation methods are most commonly used in the UK.