FIFO stands for "First In, First Out." At its core, it's an inventory management and valuation method where the first items added to your stock are assumed to be the first ones sold or used. Think of it like a queue: the first one in line is the first one to be served. This approach is crucial for businesses dealing with perishable goods or items that can become obsolete, as it helps prevent spoilage, keeps products fresh, and allows for clear traceability of product batches.

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The mechanics of FIFO are pretty straightforward:
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• Record Keeping: Each new inventory arrival isnew inventory arrival is recorded, often with details like its arrival date and, if applicable, its expiration date.
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• Stock Rotation: When it's time to sell products or use them in production, the oldest items – those that arrived first – are picked. If you're dealing with items with expiration dates, you'd prioritize moving the stock with the nearest expiration dates.
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• Minimizing Waste: This systematic rotation ensures that older stock is used before it expires or becomes outdated, which can save a company from costly write-offs.

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Let's walk through an example to see FIFO in action.
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Imagine your manufacturing company sells industrial conveyor belts. You've just sold 250 identical conveyor belts. Your purchase history for these belts, which were bought in three batches at different prices, looks like this:
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• March 1st: 200 conveyor belts at $10,000 each
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• March 16th: 150 conveyor belts at $12,000 each
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• Later date: 225 conveyor belts at $16,000 each
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Now, you need to determine your Cost of Goods Sold (COGS) for the 250 belts sold and the value of your remaining inventory. With FIFO, we assume the first belts you bought are the ones you sold.
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Calculating COGS

You sold 250 conveyor belts.
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The first 200 belts sold are from the March 1st batch (the oldest stock).

200 units × $10,000/unit = $2,000,000
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The remaining 50 belts sold (250 total - 200 from first batch) come from the March 16th batch.

50 units × $12,000/unit = $600,000
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Your total Cost of Goods Sold (COGS) is $2,000,000 + $600,000 = $2,600,000.
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Calculating Ending Inventory

Next, let's figure out what's left in your inventory.
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• From the March 1st batch: 200 purchased - 200 sold = 0 remaining.
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• From the March 16th batch: 150 purchased - 50 sold = 100 remaining.
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• From the latest batch: 225 purchased - 0 sold = 225 remaining.
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So, you have 100 + 225 = 325 conveyor belts left.
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Calculate the value of ending inventory

The 100 remaining units from the March 16th batch are valued at their purchase price:

100 units × $12,000/unit = $1,200,000
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The 225 units from the latest batch are valued at their purchase price:

225 units × $16,000/unit = $3,600,000
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Your total ending inventory value is $1,200,000 + $3,600,000 = $4,800,000.
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This example shows that FIFO matches the older, lower costs with your sales revenue during rising prices (from $10,000 to $16,000 per belt). Your COGS uses these earlier costs ($10,000 and $12,000), while your ending inventory is valued at the more recent, higher costs ($12,000 and $16,000). This means FIFO might not always perfectly align current revenue with the most current costs, as COGS is based on what you paid earlier.

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FIFO isn't the only way to value inventory. Another common method is LIFO (Last In, First Out). Here’s a quick comparison:
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FIFO offers several benefits, but it also has some drawbacks.

Advantages

• Logical Flow: FIFO mirrors the actual physical flow of goods for many businesses, especially those dealing with perishable or date-sensitive items. It's intuitive.
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• Prevents Spoilage & Obsolescence: By selling older items first, businesses reduce the risk of products expiring or becoming outdated on the shelves.
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• Accurate Balance Sheet: Your balance sheet's ending inventory reflects the cost of the most recently purchased items. During rising prices, this means your inventory asset is valued closer to current market prices.
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• Widely Accepted: FIFO is permitted under Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
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• Higher Reported Income (During Inflation): In inflationary periods, FIFO results in a lower COGS (since older, cheaper goods are "sold" first), which leads to higher reported net income. This can be appealing to investors and lenders.
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Disadvantages

• Higher Taxes (During Inflation): Higher reported net income during inflation also means a higher tax bill.
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• Mismatch of Costs and Revenue: In periods of rapidly rising prices, COGS might not reflect the current cost of replacing those items. This can make it seem like your profit margins are higher than they would be if COGS were based on current replacement costs.

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FIFO's popularity stems from a combination of factors:
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• Simplicity and Logic: It's easy to understand and often aligns with the natural way businesses handle their stock.
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• Reduces Waste: For companies that produce perishable goods (like food or pharmaceuticals) or products with short lifecycles (like electronics), FIFO is essential for minimizing losses due to spoilage or obsolescence.
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• Regulatory Compliance: Its acceptance under major accounting standards like IFRS and GAAP makes it a safe choice for many companies, especially those operating internationally.
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• Balance Sheet Accuracy: It tends to provide a more current valuation of inventory on the balance sheet.

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Last In, First Out (LIFO)

• Concept: The newest items added to inventory are assumed to be sold first.
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• Effect: During inflationary times, LIFO generally results in a higher Cost of Goods Sold (COGS) and lower gross profit. This can lead to a lower taxable income and, consequently, lower taxes owed.
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• Benefits: It can act as a hedge against inflation and price volatility by more closely matching recent revenues with recent costs. This may also reduce the likelihood of inventory write-downs if prices are falling. Note: LIFO is not permitted under IFRS.
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Weighted Average Cost (WAC)

Concept: This method smooths out price fluctuations. The total cost of goods available for sale is divided by the total number of units available for sale to get an average cost. All units are then valued at this average cost.
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Best For:
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• Companies where inventory items are indistinguishable or have little price variation.
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• Businesses with high-volume, standardized products.
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• Operations that don't have sophisticated systems for tracking individual purchase costs for FIFO/LIFO.
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• Situations involving commoditized goods where per-unit cost differences are minimal.
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Advantage: It's generally easier to implement and manage, especially for smaller businesses with limited resources.
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First Expired, First Out (FEFO)

• Concept: FEFO is very similar to FIFO, but it places strict priority on product expiration dates. The items closest to their expiration date are sold or used first, regardless of when they were acquired (though usually, earlier acquired items have earlier expiration dates).
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• Use Case: This is critical for industries that handle perishable goods, such as dairy products, pharmaceuticals, fresh food, and other consumables with strict shelf lives. The primary goal is to minimize spoilage and ensure product safety.

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The First In, First Out (FIFO) method is a widely used and logical inventory management and valuation approach. By assuming that the oldest inventory items are sold first, businesses can reduce waste, maintain product quality, and present a balance sheet that reflects current inventory values. While it might lead to higher taxes in inflationary periods, its simplicity, alignment with physical inventory flows for many industries, and acceptance under major accounting standards make it a go-to choice for numerous companies. Understanding FIFO is key to understanding how businesses manage their stock and report financial health.