First in First out Method (FIFO)

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Definition and Explanation:

The FIFO method uses the price of first batch received for costing all units of sales until all units from this batch have been sold; after which the price of the next batch received is used for costing purposes. Upon that batch being fully sold the price of the next batch received is used and so on.

Advantages:

(i) The inventory is valued at the price of the most recently acquired goods and thus closes to current market value.

(ii) FIFO is more realistic, as based on actual costs and relates to physical flow of goods especially when goods are perishable.

(iii) FIFO is acceptable to the inland revenue.

(iv) Inventories are valued at the actual prices paid to suppliers.

(v) FIFO method is simple and easy to use.

Disadvantages:

(i) In time of rising prices, use of FIFO results in lower costs of sales and higher inventory values as such profits will be inflated which is against prudence concept.

(ii) Identical items of inventory may be valued at different prices, when sold on same date or issued to similar jobs.

(iii) Businesses which apply “cost plus pricing” for determining prices of their products may face problems in pricing decisions due to problem mentioned in above point.

(iv) When goods are returned to suppliers, the cost at which it was purchased is to be reduced from the inventory balance. But the balance column may not have any such lot.

Solved Problems and Examples:

Problem # (1):

Don Barco has recently started a new business which deals in a single product. The first three months of his year of trading showed the following purchases and sales:

fifo

Required:

Calculate value of inventory as at 31 March 2015 under FIFO method of inventory valuation.

Solution # (1):

Calculation of Closing Inventory (FIFO Perpetual and FIFO Periodic)

fifo solution

Problem # (2):

Caveat Emptor buys and sells a single product from two years. His first three months of current year’s trading showed the following purchases and sales.

fifo 2

Caveat had 110 units in inventory on 31 December 2014 costing $11 each.

For your convenience you may assume that all purchases took place at the first day of each month, whereas sales are made on the last day of the relevant month.

Required:

Calculate the closing inventories under both FIFO Perpetual and FIFO Periodic systems.

Solution # (2):

Calculation of Closing Inventory (FIFO Perpetual and FIFO Periodic)

fifo solution 2