Lesson 35: FIFO Method and Inventory Costing
In this lesson, we will learn how the FIFO method is used,
and look at an example of this inventory costing system. We will finish by
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.
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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.
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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).
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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.
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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.
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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.