Have you heard of the first in, first out (FIFO) accounting method? It’s used by countless businesses to track their respective inventory. With the FIFO method, businesses assume their oldest products have been sold first. Businesses can then include these assets in their respective cost of goods sold (COGS). All other assets will be valued according to this information. While the FIFO accounting method may sound complex, however, it works in a relatively simple way.
Overview of FIFO
FIFO is an accounting method that’s designed to help businesses assume their cash flow. Businesses, of course, must spend money to move inventory. It costs money to produce, market, sell and distribute products. Under the FIFO accounting method, a business will assume that its oldest products have been sold first. With this information in hand, the business can calculate its COGS. COGS is calculated using the FIFO accounting method by taking the cost of a business’s oldest product and multiplying it by the number of units of solds.
A business may not necessarily sell its oldest products first. It may sell newer units of a specific product before the older units. Regardless, the FIFO accounting method works on the assumption that oldest products are sold first. Any remaining and unsold units of a product are then considered new.
FIFO vs LIFO: What’s the Difference?
There’s also the last in, first out (LIFO) account method. As you may have guessed, the LIFO accounting method contrasts with the FIFO method by assuming a business’s newest products are sold first.
FIFO is an older and more common accounting method. It wasn’t until the 1970s when it picked up momentum as a way for businesses to reduce their income taxes. The Internal Revenue Service (IRS), however, has since adjusted its code to prevent businesses from monetary benefiting from the use of the LIFO accounting method.
To recap, FIFO is an accounting method that involves cash flow assumptions based on the sale of a business’s oldest products first. Businesses typically don’t move all their inventory overnight. It can take months or years for a business to sell its products. Even then, it may not sell all of its products. Under the FIFO accounting method, a business will assume its oldest products are first.
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