What is FIFO and how is it calculated?

FIFO is an acronym for first in, first out. It is a cost layering concept under which the first goods purchased are assumed to be the first goods sold. The concept is used to devise the valuation of ending inventory, which in turn is used to calculate the cost of goods sold.

Characteristics of FIFO

A company that uses FIFO will find that the costs it maintains in its records for its inventory will always be the most current costs, since the last items purchased are still assumed to be in stock. Conversely, the cost of the oldest items will be charged to the cost of goods sold. In a normal inflationary environment, this means that the cost of goods sold will be relatively low in comparison to current costs, which will increase the amount of taxable; also, the inventory value reported on the balance sheet will approximately match current costs.

To calculate COGS (Cost of Goods Sold) using the FIFO method, determine the cost of your oldest inventory. Multiply that cost by the amount of inventory sold.

Keep in mind that the prices paid by a company for its inventory often fluctuate. These fluctuating costs must be taken into account.

The FIFO concept is best shown with the following example.

 

Received 10 on December 1 at a cost of 7.58 = $758.00 in the inventory GL and the physical/shelf inventory

Received 20 on December 31 X 10.49 = $209.80 in the inventory GL and the physical/shelf inventory

An item that is sold today would use the "first" cost, or $7.58, to calculate the gross profit and margins on the work order and to credit inventory/debit COGS with this method. Once ten have been sold at the cost of 7.58, the system will then use the cost of 10.49 for the next sales.

You can tell if your warehouse is set to use FIFO by accessing Parts Items Setup in the top toolbar of the Parts inquiry module.

On the Warehouses tab, if the FIFO Inventory Cost option is selected the system will track individual cost and use that for FIFO costing.  If it is unchecked, the system will use the cost on the part record (also known as replacement cost).

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