Definition: FIFO method, first-in, first-out, is an inventory valuation and cost allocation system that assigns costs to merchandise based on the order it was purchased; the first products purchased should be the first ones sold.
What Does FIFO Method Mean?
What is the definition of FIFO Method? FIFO is better termed as a philosophy that companies use when evaluating the inventory of a business. Many food-based businesses, such as grocery stores, ensure that his principle operates by placing the oldest food items and the front and the newer ones in the back. FIFO itself is an acronym for ‘first-in, first-out’.
FIFO method is the most common way of evaluating and calculating an organization’s inventory. The purpose of having a method for evaluating inventory is important because inventory is not all at a uniform price. Below is an example of how the FIFO method would be used to calculate actual goods sold.
May 6th – 20 units of product X at $65/unit
May 12th – 30 unites of product X at $70/unit
May 18th- 25 units of product X at $45/unit
The business that stocks product X has sold 25 units as of May 30th of the same year. Here’s how the May 30th inventory is valued:
20 x $65 (May 6th inventory) + 5 x $70 (May 12th inventory) = $1,650.
Let’s take a look at another example.
Example
James owns a business called Club Jay Jays. Club Jay Jays specializes in selling athletic equipment. James decided to make to buy 20 bats for his inventory at 30 USD each. In the subsequent week, James decided to make an additional purchase order of 30 bats at 40 USD each. After a month, James calculated that he had sold a total of 30 bats. Using the first in first out method, here are his calculations for bat sales below:
First 20 bats – 30 USD
Second 30 bats – 40 USD
30 bats sold = (20 x 30)+(10 x 40) = 1,000 USD worth of equipment sold.
By using FIFO, he must conclude that all the bats in the first batch were sold before any of the more expensive bats in the second batch.
Summary Definition
Define FIFO Method: First In, First Out method means an inventory cost allocation technique where the first merchandise purchased is the first to be sold.
