To calculate FIFO (First-In, First-Out), you determine the cost of your oldest inventory and multiply that cost by the amount of inventory sold.
Understanding FIFO
FIFO, or First-In, First-Out, is an inventory valuation method that assumes the first items placed in inventory are the first items sold. This means that the cost of the oldest inventory is used to determine the cost of goods sold (COGS). In contrast to LIFO, where the most recent inventory costs are used, FIFO focuses on the oldest costs.
Calculating FIFO Step by Step
Here’s a step-by-step guide to calculating FIFO:
- Identify the Inventory: Track each purchase of inventory, including the quantity and cost of each item.
- Determine the Units Sold: Calculate the total number of items sold during a specific period.
- Apply the FIFO Principle: Start by using the cost of the oldest inventory to calculate the cost of goods sold. Continue using older inventory costs until all the sold units are accounted for.
- Calculate COGS: Multiply the cost of each older inventory item by the number of units sold from that batch and sum the results for your total COGS.
Example of FIFO Calculation
Suppose a business made the following inventory purchases:
| Date | Units Purchased | Cost per Unit |
|---|---|---|
| January 1 | 100 | $10 |
| January 15 | 200 | $12 |
| January 30 | 150 | $15 |
And suppose the business sells 300 units in total. Here's how to calculate COGS using FIFO:
- First 100 units sold: The cost per unit is $10 (from January 1). Cost = 100 * $10 = $1000
- Next 200 units sold: The cost per unit is $12 (from January 15). Cost = 200 * $12 = $2400
- Total COGS: $1000 + $2400 = $3400
Therefore, under FIFO, the cost of goods sold is $3400.
FIFO vs LIFO
According to the reference, it's important to note the distinction between FIFO and LIFO:
- FIFO (First-In, First-Out): Uses the oldest inventory costs to calculate COGS.
- LIFO (Last-In, First-Out): Uses the most recent inventory costs to calculate COGS.
Advantages of FIFO
- Simple to Understand: FIFO is straightforward and easy to understand and implement.
- Realistic Inventory Valuation: The remaining inventory typically reflects newer purchases, aligning better with the actual physical flow of goods.
Disadvantages of FIFO
- Higher Income: In times of inflation, using older, cheaper inventory can inflate profits and possibly tax burdens.
