FIFO is one of the most widely used ways to value inventory. For many businesses, it also matches how stock really moves. A grocery store, for example, sells its oldest milk before its newest shipment. That cuts spoilage, and it happens to match how FIFO accounting works too.

How FIFO Works

Under FIFO, cost of goods sold is worked out using the cost of the oldest stock first. As older, often cheaper stock gets "used up" in the math, the stock left on the books reflects newer, often higher purchase costs.

A Simple Example

Suppose a business buys 100 units at $10 each, then later buys another 100 units at $12 each. If it sells 120 units, FIFO assumes the first 100 sold came from the $10 batch. The remaining 20 came from the $12 batch. Cost of goods sold would be (100 × $10) + (20 × $12) = $1,240. The 80 units left in inventory would be valued at $12 each.

Why Businesses Use FIFO

FIFO tends to keep balance sheet inventory values closer to today's cost, since the stock left over reflects more recent purchase prices. It's also the natural choice for goods that spoil or go out of style quickly. There, selling older stock first matters for the business day to day, not just for the books.

FIFO During Rising Prices

When purchase costs rise, FIFO tends to show lower cost of goods sold and higher profit. That's because it uses older, cheaper costs against current sales. LIFO behaves the opposite way under the same conditions. That's one reason the choice between the two matters for financial reporting.

Key Takeaways

FIFO values inventory by assuming the oldest stock sells first, which often mirrors how stock really moves. It tends to keep balance sheet values closer to current costs. It's also a common default for goods that spoil or go out of style quickly.

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