Lesson Objectives:- How the FIFO method is used.
- Example of the inventory costing system
- Calculating cost of goods sold and ending inventory.
The FIFO (first in, first out) method is the next costing system that is used for determining the cost of goods sold.
This method simply requires the first goods that are purchased to be the first goods sold and expensed, hence the terms first in, first out. This method is used very often in grocery stores as many items have a limited shelf life and the oldest product is expensed first.
When the FIFO method is used, the company will conclude with the same amount of ending inventory regardless of whether the perpetual or periodic inventory system is used. This is important to know because other inventory costing systems such as the average cost assumption method differ between the two types of inventory systems.
Let's take a look at exactly how the FIFO method is used.
A grocery store purchases loaves of bread on January 2nd and they make another purchase for loaves of bread on January 11th. When the bread is sold to customers, the loaves purchased on January 1st will be expensed first because it was the first product in.
Now, we will expand this concept into how it is used on a more complex level to determine the cost of goods sold and ending inventory at the end of the month. The table above represents a series of transactions from January 1st to the 20th.
Let's start by finding out how much our inventory is worth. To do this, we simply multiply the number of units on the beginning inventory row and the purchase rows by the unit cost to come up with the total units and value of inventory. Take a look at how this is calculated above.
Next, we will use these values to calculate the cost of goods sold using the FIFO method. The company's first sale entry of 300 units had a cost of $2.00/unit. It will be expensed first for a total of $600 because it was the beginning inventory (first in).
We will then look at the next sale of 250 units. 200 of those units can be expensed at $3.00/unit for a total of $600 and the next 50 would be expensed at $3.50/unit for a total of 175.
If we add up the expense entries, we will come up with $1,375 for the total cost of goods sold.
We've sold 550 units for a cost of $1,375.
We still have 350 units left and need to calculate the ending inventory figure. We would simply subtract the cost of goods sold from the total inventory value to come up with the ending inventory figure of $1,375.
That concludes the example of how you will calculate the cost of goods sold and ending inventory.
Be sure that the oldest inventory is expensed first using the unit costs, not the sales prices, to calculate the cost of goods sold. The sales prices will be used for revenue figures which we will be reviewing in upcoming lessons.