FIFO

FIFO, short for first in, first out, is an inventory cost formula that assigns the earliest acquired or produced costs to cost of goods sold first. The costs left in ending inventory therefore come from the most recent purchases or production layers.

FIFO describes accounting cost flow. It does not require each physical item to leave the warehouse in that order, although it often resembles the physical rotation of perishable or time-sensitive goods.

Key Takeaways

• FIFO expenses the oldest available costs first and leaves newer costs in ending inventory.
• When unit costs rise, FIFO generally reports lower cost of goods sold and higher gross profit and ending inventory than LIFO.
• When unit costs fall, the directional comparison generally reverses.
• FIFO is permitted under both U.S. GAAP and IFRS.
• FIFO usually produces the same ending inventory under periodic and perpetual systems when the same purchases and sales are included, unlike LIFO or some average-cost applications.

Worked Example: FIFO Cost Assignment

Assume a retailer has these units available:

The retailer sells 120 units for $18 each. Under FIFO, the oldest costs are assigned first:

FIFO cost of goods sold = (100 x $10) + (20 x $12) = $1,240

FIFO ending inventory = 80 x $12 = $960

Sales = 120 x $18 = $2,160

Gross profit = $2,160 - $1,240 = $920

The physical goods sold could be different units. FIFO determines which costs are expensed and which remain on the balance sheet.

FIFO Compared With LIFO and Weighted Average

Using the same example, the weighted-average unit cost is $11 ($2,200 / 200 units).

The difference is entirely caused by cost assignment. All three methods use 200 available units, sell 120, and leave 80. When costs are rising, FIFO moves the cheaper layer to expense first.

Financial Statement Effects

In a sustained rising-cost environment, FIFO tends to produce:

• lower cost of goods sold than LIFO because older, cheaper costs are expensed;
• higher gross profit and pretax income, all else equal;
• higher ending inventory because newer costs remain in the asset balance; and
• a balance sheet closer to recent acquisition cost than LIFO layers that may be much older.

These are tendencies, not guarantees. Purchase timing, sales volume, price volatility, write-downs, product mix, and inventory reductions can change the observed relationship.

FIFO does not make the business economically more profitable. It changes the timing and location of cost recognition under the accounting model.

FIFO Under U.S. GAAP and IFRS

FIFO is an accepted cost formula under both major frameworks for appropriate inventory. Under IAS 2, specific identification is used for noninterchangeable items, while FIFO or weighted average is used for ordinarily interchangeable items. U.S. GAAP also permits FIFO.

For subsequent measurement:

• U.S. GAAP inventory measured using FIFO is generally subject to lower of cost and net realizable value.
• IFRS measures inventory at lower of cost and net realizable value and can require reversal of a prior write-down if net realizable value recovers, limited to the original write-down.

Method permission does not eliminate the need to test obsolescence, damage, price declines, and completion or selling costs.

Periodic vs Perpetual FIFO

Under a perpetual system, each sale removes the oldest costs available at that transaction date. Under a periodic system, FIFO is applied to the period’s goods available after period-end quantities are known.

FIFO generally reaches the same ending layers under either system because the newest units remain after the total period sales. The systems can still differ operationally through cutoff errors, returns, transfers, shrinkage, and item-level records.

How Analysts Should Evaluate FIFO Inventory

1. Read the inventory accounting-policy note and confirm where FIFO is used; a company can use different formulas for different inventory groups when the framework permits and the nature or use differs.
2. Reconcile inventory growth with sales, unit volume, price changes, acquisitions, and supply decisions.
3. Compare gross margin with purchase-cost inflation. FIFO margins can lag current replacement costs because older costs are in cost of goods sold.
4. Review write-down and obsolescence policies rather than assuming a recent cost layer is fully recoverable.
5. Check cash taxes and local tax methods separately. Financial reporting method and tax consequences depend on jurisdiction.
6. Compare inventory turnover using consistent definitions and average balances.

Common Mistakes and Limitations

• Equating FIFO with physical flow: The accounting formula can differ from warehouse movement.
• Calling higher FIFO profit a cash gain: Cost assignment changes reported timing; cash depends on sales, purchases, collections, and taxes.
• Ignoring cost direction: The familiar higher-profit result assumes rising unit costs.
• Comparing gross margins mechanically: Product mix, markdowns, freight classification, and supplier rebates may matter more than the cost formula.
• Treating newer ending cost as market value: Recent purchase cost can still exceed net realizable value.
• Assuming all inventory uses FIFO: Read the policy and category disclosures.

This page is educational and is not accounting, tax, or investment advice.

Official Resources

• IFRS Foundation: IAS 2 Inventories explains permitted cost formulas and lower-of-cost-and-NRV measurement under IFRS.
• FASB ASU 2015-11, Inventory (Topic 330) addresses subsequent measurement of FIFO and other non-LIFO inventory under U.S. GAAP.
• IRS Publication 538 compares FIFO and LIFO for U.S. federal tax accounting and explains inventory method administration.

Related Terms

• LIFO
• Inventory Accounting
• Inventory
• Cost of Goods Sold
• Inventory Turnover