How to Calculate FIFO and LIFO

FIFO, or First In, Fast Out, is a common inventory valuation method that assumes the products purchased first are the first ones sold. This calculation method typically results in a higher net income being recorded for the business. Keeping track of all incoming and outgoing inventory costs is key to accurate inventory valuation. Try FreshBooks for free to boost your efficiency and improve your inventory management today. FIFO, or First In, First Out, is an inventory valuation method that assumes that inventory bought first is disposed of first. Companies frequently use the first in, first out (FIFO) method to determine the cost of goods sold or COGS.

The Basics of Small Business Accounting: A How-to

All companies are required to use the FIFO method to account for inventory in some jurisdictions but FIFO is a popular standard due to its ease and transparency even where it isn’t mandated. The FIFO method can result in higher income taxes for a company because there’s a wider gap between costs and revenue. The alternate method of LIFO allows companies to list their most recent costs first in jurisdictions that allow it.

What Are the Other Inventory Valuation Methods?

The cost of goods sold for 40 of the items is $10 and the entire first order of 100 units has been fully sold. The other 10 units that are sold have a cost of $15 each and the remaining 90 units in inventory are valued at $15 each or the most recent price paid. Using FIFO does not necessarily mean that all the oldest inventory has been sold first—rather, it’s used as an assumption for calculation purposes. Learn more about what FIFO is and how it’s used to decide which inventory valuation methods are the right fit for your business. But regardless of whether your inventory costs are changing or not, the IRS requires you to choose a method of accounting for inventory that’s consistent year over year.

1. As you can see, the FIFO method of inventory valuation results in slightly lower COGS, higher ending inventory value, and higher profits.
2. Learn the fundamentals of small business accounting, and set your financials up for success.
3. FIFO is required under the International Financial Reporting Standards and it’s also standard in many other jurisdictions.
4. If you’re wanting to try it for yourself, there are free templates available online.
5. If the dealer sold the desk and the vase, the COGS would be $1,175 ($375 + $800), and the ending inventory value would be  $4,050 ($4,000 + $50).

Cost Accuracy

It may also understate profits, which can make the business less appealing to potential investors. Using the FIFO method makes it more difficult to manipulate financial statements, which is why it’s required under the International Financial Reporting Standards. Depending upon your jurisdiction, your business may be required to use FIFO for inventory valuation. To calculate the value of inventory using the FIFO method, calculate the price a business paid for the oldest inventory batch and multiply it by the volume of inventory sold for a given period.

This helps keep inventory fresh and reduces inventory write-offs which increases business profitability. FIFO is straightforward and intuitive, making it popular as an accounting method and useful for investors and business owners trying to assess a company’s profits. It’s also an accurate system for ensuring that inventory value reflects the market value of products. It’s also the most accurate method of aligning the expected cost flow with the actual flow of goods.

This is especially true for businesses that sell perishable goods or goods with short shelf lives, as these brands usually try to sell older inventory first to avoid inventory obsoletion and deadstock. First-In, First-Out (FIFO) is one of the methods commonly used to estimate the value of inventory on hand at the end of an accounting period and the cost of goods sold during the period. This method assumes that voucher ideas examples 2023 inventory purchased or manufactured first is sold first and newer inventory remains unsold. Thus cost of older inventory is assigned to cost of goods sold and that of newer inventory is assigned to ending inventory. The actual flow of inventory may not exactly match the first-in, first-out pattern. To ensure accurate inventory records, one of the most common inventory valuation methods is FIFO (first-in, first-out), which assumes the oldest inventory items were sold first and the value is calculated accordingly.

Notice that Susan lists the local bookkeeping services near me 130 units remaining in her inventory as costing $4 apiece. This is because she presumes that she sold the 80 units that she bought for $3 apiece first. To calculate the value of ending inventory using the FIFO periodic system, we first need to figure out how many inventory units are unsold at the end of the period.

LIFO, or Last In, First Out, is an inventory value method that assumes that the goods bought most recently are the first to be sold. When calculating inventory and Cost of Goods Sold using LIFO, you use the price of the newest goods in your calculations. Since under FIFO method inventory is stated at the latest purchase cost, this will result in valuation of inventory at price that is relatively close to its current market worth.

Why Is the FIFO Method Popular?

The FIFO method impacts how a brand calculates their COGS and ending inventory value, both of which are always included on a brand’s balance sheet at the end of a financial accounting period. For instance, if a brand’s COGS is higher and profits are lower, businesses will pay less in taxes when using LIFO and are less at risk of accounting discrepancies if COGS spikes. However, brands using LIFO usually see a lower valuation for ending inventory and net income, and may not reflect actual inventory movement. FIFO assumes that the oldest products are sold first, but it’s important to make sure that this practice is actually applied to your warehouse. Learn more about the difference between FIFO vs LIFO inventory valuation methods.