First in, first out (FIFO)
The first in, first out (FIFO) costing method assumes two things:
- The items purchased or producedfirstwere also the first items sold.
- The inventory items at the end of your reporting period are matched with the costs of related items recently purchased or produced.
The price of items often fluctuates over time, due to market value or availability. Inflation causes prices to increase over time. Deflation causes prices to decrease over time. Depending on how those prices impact a business, the business may choose an inventory costing method that best fits its needs.
During inflation, the FIFO method assumes a business’s least expensive products sell first. As prices increase, the business’s net income may increase as well. This process may result in a lower cost of goods sold compared to the LIFO method. However, during price deflation, the opposite may occur.
For example, a jeweller makes 10 gold rings in a month. When production started, it cost $100 to make gold rings. Due to inflation, the cost to make rings increased before production ended. By the end of production, gold rings cost $150 to make. Using FIFO, the jeweller would list COGS as $100, regardless of the price it cost at the end of the production cycle. Once those 10 rings are sold, the cost resets as another round of production begins.
