What is FIFO Method?
FIFO (First-In, First-Out) is a method of inventory management that prioritizes selling or using the oldest batch of inventory. It aims to reduce instances of expired & obsolete inventory, minimize wastage, and improve the overall quality.
The FIFO method is extremely common across industries in India, including food & beverage, pharmaceuticals, groceries & supermarkets, restaurants & cafes, medical devices, and chemicals. ERP software helps identify the oldest stock, streamline warehouse operations, and track key details about inventory batches (such as batch number, quantity, and receipt date).
Key Takeaways:
- FIFO (First-In First-Out) is a widely used inventory valuation method that involves selling or using the oldest inventory first.
- The FIFO inventory method is ideal for perishable items such as food, groceries, and pharmaceutical products with limited shelf-life.
- FIFO is accepted globally under GAAP and is fully compliant with the Indian Accounting Standards (Ind AS).
- Adopting the FIFO inventory method helps businesses improve accuracy, reduce waste & spoilage, and enhance the company’s cash flow
FIFO Method in Inventory Management
As discussed above, in the FIFO method, the earliest goods purchased are removed first from the inventory. So the remaining items in the inventory will be incurred with the most recent costs. And when the inventory asset is recorded in the balance sheet there won’t be much difference and will be close to the most recent costs procured from the marketplace.
On the contrary, this inventory method goes against matching the historical costs with the current revenue and records it in the cost of goods sold(COGS). As a result, the gross margin doesn’t always reflect the right matching of costs and revenue.
The FIFO method is accepted by international financial reporting standards.
Also Read : What is ABC Analysis in Inventory Management System?
Difference Between FIFO & LIFO
In the FIFO method, the oldest goods are sold first, whereas in the LIFO method, the most recent goods are sold first. Here’s the difference between these two inventory methods:
| FIFO (First-In, First-Out) | LIFO (Last-In, First-Out) | |
|---|---|---|
| Meaning | FIFO is an inventory rotation method that focuses on selling or using the oldest inventory first | LIFO is an inventory rotation method that focuses on selling or using the newest inventory first |
| Best Suited For | Food, pharma, and perishable items | Non-perishable items |
| Example | A food company sells its oldest batch of products | A hardware store buys steel bolts at different prices. It sells the latest stock (higher priced) first and older stock (lower priced) later |
| Ease of Understanding | Simple and straightforward | Relatively difficult |
| Year-end Inventory Value | Newer purchase prices | Older purchase prices |
| Cost of Goods Sold (COGS) | Older inventory costs first | Newer inventory costs first |
| Impact during increasing prices | Lower COGS | Higher COGS |
| Impact during decreasing prices | Higher COGS | Lower COGS |
| Inflation Effect | Higher taxable income | Lower taxable income |
| Regulatory Acceptance | Widely popular. Permitted under Indian Accounting Standards (Ind AS). Globally accepted under GAAP | Not permitted under IFRS and Indian Accounting Standards (Ind AS) |
Advantages & Disadvantages of the FIFO Method
Much like any other inventory method, the FIFO method has both advantages and disadvantages. The FIFO method is widely accepted under Indian Accounting Standard 2. It is both simple and a realistic way for inventory calculation. However, a majority of the disadvantages of the FIFO method are related to the inflation period when older & cheaper inventory costs a lower COGS, leading to higher “reported profits” and higher tax liability.
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How to Calculate FIFO Method in Inventory Management with Examples
To use the FIFO inventory calculation method, you need to know the cost of the oldest inventory, in addition to the cumulative cost of production or the cost of procuring finished products for resale purposes. The cumulative cost of production includes everything from overhead, cost of finished goods, labor, and materials.
FIFO Calculation Formula
Cost of Goods Sold (COGS):
COGS = Σ (Units issued from each inventory layer × Cost per unit of that layer)
Ending Inventory:
Ending Inventory = Total Inventory Cost − COGS
Examples of FIFO Method
On January 1, a local trader in Navi Mumbai purchases 50 units of computers at Rs. 45,000 each. On January 26, he purchases another lot of 50 units at Rs. 60,000 each.
Because FIFO follows the logical flow of inventory, the trader sells the first 50 units at Rs. 45,000 each (i.e., Rs. 22,50,000). He sells the subsequent 50 units at Rs. 60,000 each (i.e., Rs. 30,00,000).
| Date | Transaction | Units | Per Unit Cost | Total Cost | Total Revenue |
|---|---|---|---|---|---|
| Jan 1 | Purchase | 50 | ₹45,000 | ₹22,50,000 | |
| Jan 26 | Purchase | 50 | ₹60,000 | ₹30,00,000 | |
| Jan 31 | Sale | 100 | First 50 at ₹45,000
Next 50 at ₹60,000 |
₹52,50,000
(₹22,50,000 + ₹30,00,000) |
₹52,50,000 |
FIFO Calculation:
If the trader sells all 100 computers:
First 50 units: 50 × ₹45,000 = ₹22,50,000
Next 50 units: 50 × ₹60,000 = ₹30,00,000
Total Cost of Goods Sold (COGS):
COGS = ₹22,50,000 + ₹30,00,000 = ₹52,50,000
So, under FIFO, the COGS is ₹52,50,000 when all 100 units are sold.
Ending Inventory:
Ending Inventory = ₹52,50,000 − ₹52,50,000 = ₹0
Also Read : What is FSN analysis in Inventory Management?
Other Inventory Valuation Methods
Beyond FIFO and LIFO, there are other inventory valuations methods you should know about.
- FEFO (First Expired, First Out): While FIFO sells the oldest purchased items first, FEFO first sells the items nearing expiry date. This is especially useful in pharma, food and chemical industry, having products with limited shelf life.
- Weighted Average Cost: WAC method is used to average the cost of all inventory. This simplifies COGS calculation, but may not be suitable when prices fluctuate a lot.
- Specific Identification Method: Under this method, every individual product is assigned a cost based on its specific value. This is ideal for high-value or unique items, such as jewellery and artwork.
Why is the FIFO Method Popular?
The FIFO method is very popular across the world as it aligns the inventory cost flow with the actual flow of goods, thus providing a realistic picture of your inventory. It mimics how stock moves in real life (i.e., older inventory is sold first and the newer later). It helps enterprises reduce the risk of expiring products, preventing waste accumulation and potential financial losses. It is also compatible with the Generally Accepted Accounting Principles (GAAP) established by the Financial Accounting Standards Board (FASB) and IAS 2 Inventories of the IFRS standards, which govern the inventory cost determination and subsequent recognition of the cost as an expense.
Unlock Efficient FIFO Inventory Management with Sage X3
The process of inventory assessment impacts a company’s profits. FIFO is a widely popular and primary inventory method in most ERP software that chooses the oldest items for sale or use over the new ones. It helps reduce waste, spoilage, and stock obsolescence. It delivers realistic reporting of the inventory costs, improves overall efficiency, and boosts cash flow.
Sage X3 lets you manage inventory across multiple branches. It offers a dedicated module to automate inventory tracking in real-time, Lot & Serial number tracking, and inventory replenishment. It provides extensive warehouse control, precise demand planning, and supply chain capabilities, helping you fulfil orders quickly and maximise customer satisfaction.
FIFO Method FAQs
1. What are the 4 Inventory Methods?
The four inventory methods are FIFO (First-In, First-Out), LIFO (Last-In, First-Out), Weighted Average Cost, and Specific Identification. They are used to calculate the Cost of Goods Sold (COGS) and the value of remaining inventory.
2. Which is Better, FIFO or LIFO?
Neither FIFO nor LIFO is better. The use of each inventory method depends on different factors and a company’s strategic goals & objectives. Companies engaging in the sale of perishable items prefer FIFO. However, this method is not exclusive to perishable items alone. It is used worldwide due to the GAAP and IFRS requirements. While the LIFO method is banned by the IFRS, it is allowed in the US under GAAP. It is useful for companies looking to reduce their taxable income and match costs to revenue.
3. What is FIFO & LIFO in Inventory?
Both FIFO and LIFO are two types of inventory methods. FIFO stands for First-In, First-Out, which calculates the cost of your oldest inventory purchases. In contrast, LIFO (Last-In, First-Out) calculates the cost of your newest inventory purchases. Using the correct inventory valuation method is important to ensure accurate profit recording, tax liabilities, and efficient capital usage.
4. How does the FIFO Method affect Financial Statements?
When the inventory costs are rising, FIFO helps to record cheaper, older stock first. This results in higher net income on the income statement as low-cost inventory reduces COGS. FIFO also increases inventory value on the balance sheet as high-cost inventory remains unsold.
