First In, First Out (FIFO): Definition

First in, first out (FIFO) is an inventory costing method that assumes the costs of the first goods purchased are the costs of the first goods sold.

In terms of flow of cost, the principle that FIFO follows is clearly reflected in its name. Specifically, FIFO assumes that the first cost received in stores is the first cost that goes out from the stores.

In other words, under FIFO, the cost of materials is charged to production in the order of purchases. Earlier costs recorded in materials ledger cards are used for costing requisitions, and the balance consists of units received later.

FIFO Method of Costing: Explanation

The FIFO method of costing is based on the assumption that the various lots of materials that are purchased are used in the same order in which they are received. That is to say, the materials are issued from the oldest supply in stock in this method of costing.

The materials used in a job or process are charged at the price of their original purchase. This is why FIFO is often referred to as the original price method.

The return of excess materials, initially issued to the factory for a particular job, to the storeroom is treated as the oldest stock on hand. It is placed on the materials card balance ahead of all the units on hand at the same price as it was issued to the factory.

Advantages of FIFO Method of Costing

The following are the main advantages of the FIFO method of costing:

  • Simple to operate because no complex calculations are involved
  • Materials used are drawn from the cost record in a legal order
  • Materials issued are charged to production at actual cost in the order of their receipt
  • Valuation of closing inventory is closer to current market price
  • Beneficial whenever the size and cost of material units are large

Disadvantages of FIFO Method of Costing

The following are the disadvantages and drawbacks of the FIFO method of costing:

  • The cost of material charged to production may not reflect the current market price
  • Record-keeping may be difficult if several purchases of the same material are made at different prices
  • Costing difficulties arise when returning items to vendors
  • Costing difficulties arise when excess materials are returned from the factory to the storeroom

Example

Consider the following:

  • April 01: Inventories on hand are 50 units at $2 and 100 units at $4.50
  • April 05: Purchased 100 units at $1.80
  • April 06: 10 units of inventories purchased on 5 April at $1.80 are returned to the supplier
  • April 10: 80 units issued to factory
  • April 15: 50 units issued to factory
  • April 20: 20 units purchased at $1.50
  • April 25: 70 units issued to factory
  • April 30: 50 units purchased at $1.70
  • April 30: 10 units returned to store out of units issued to the factory on 25 April

Required: Shows the value of the stock on hand using the FIFO method.

Solution

First in First Out (FIFO) method of costing

Frequently Asked Questions

Is the FIFO method of costing legal?

The fifo method is legal because it enforces that the oldest expenses and therefore costs should be deducted from assets. This enforces that all payments and costs are accounted for according to the number of days they were in use.

Is the FIFO method of costing practical?

It is generally said that the fifo method of costing is the most practical because it follows a natural flow. The first costs are used first, so employees know which materials are being used for production and how much they cost.

What are some of the negative traits of the FIFO method of costing?

Some negatives traits in the fifo method of costing is that it does not follow a natural flow. Therefore when materials are returned from the factory to the storeroom they will be valued at costs which were not their original purchase prices. This can lead to over valuation in closing inventory and material used in production.

If the unit costs for materials purchased on march 20th is $10.00 And $20.00, What will be the unit cost in inventory if only 10 units are left in inventory?

The total cost of these materials would be $100 so each unit would have a value of $10 in inventory.

Where is the FIFO method of costing mostly used?

The fifo method of costing is mostly used in accounting for goods that are sold. It is also advantageous to use with larger items because it helps keeping track of costs. The fifo method of costing is an accounting principle that states the cost of a good should be the cost of the first goods bought or produced. The other alternative is the lifo (last in, first out) method of costing.

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