First In, First Out
First In, First Out, commonly known as FIFO, is an asset-management and valuation method in which assets produced or acquired first are sold, used, or disposed of first.For tax purposes, FIFO assumes that assets with the oldest costs are included in the income statement's cost of goods sold (COGS). The remaining inventory assets are matched to the assets that are most recently purchased or produced.
Definition: First In, First Out (FIFO) is an asset management and valuation method where assets produced or purchased first are sold, used, or disposed of first. For tax purposes, FIFO assumes that the cost of the earliest assets is included in the cost of goods sold on the income statement. The remaining inventory assets are matched with the most recently purchased or produced assets.
Origin: The concept of FIFO originated in the fields of accounting and inventory management, becoming widely used in the early 20th century. As industrialization progressed, businesses needed an effective method to manage inventory and calculate costs, leading to the adoption of FIFO.
Categories and Characteristics: FIFO is primarily used in inventory management and accounting. Its characteristics include:
- Simple and intuitive: The FIFO method is straightforward, easy to understand, and apply.
- Reflects actual costs: Due to the first-in, first-out principle, FIFO can better reflect the actual cost of inventory.
- Tax implications: During periods of inflation, FIFO may result in higher taxable income because the lower-cost assets purchased earlier are included in the cost of goods sold first.
Specific Cases:
- Suppose a retail company purchases 100 items at $10 each in January and another 100 items at $12 each in February. In March, the company sells 150 items. According to the FIFO method, the cost of goods sold would be (100 items × $10) + (50 items × $12) = $1300.
- A manufacturing company purchases raw materials at different times, with earlier purchases being at lower costs. Using the FIFO method, the company will prioritize using the lower-cost raw materials first when calculating production costs, thus reflecting lower production costs in the financial statements.
Common Questions:
- What is the difference between FIFO and LIFO? FIFO assumes that the first purchased assets are sold first, while LIFO (Last In, First Out) assumes that the last purchased assets are sold first.
- What is the impact of using FIFO during periods of inflation? During inflation, FIFO may result in higher taxable income because the lower-cost assets purchased earlier are included in the cost of goods sold first.
