How to Calculate COGS in the FIFO Method?

What is FIFO?

First In, First Out, also known as FIFO, is a valuation method for assets or inventories. Under the FIFO method, the goods that are produced first are disposed of first. The FIFO method is also provided in the Indian accounting standard for inventory valuation. It is the most common, simple, and easy method of inventory valuation used by companies. Under this method, the inventory bought first must be sold first. Assets remaining in inventory are matched with the most recently purchased assets. During inflation, the FIFO method produces a higher value of the closing inventory, a lower cost of goods sold, and a higher gross profit. However, this model does not offer tax advantages, and it also fails to present an accurate depiction of the costs of the inventory when there is a rapid increase in prices....

How Does FIFO Work?

1. The FIFO method assumes that the first items manufactured or purchased are the first items sold and that the cost of those items is the cost of goods sold....

How to Calculate COGS in the FIFO Method?

To calculate COGS (Cost of Goods Sold) using the FIFO method, determine the cost of your oldest inventory. Multiply that cost by the amount of inventory sold....

Examples of the FIFO Method

Example 1:...

Advantages of FIFO

1. Reduced Chances of Obsolete Products: The FIFO method creates a system to sell the oldest inventory, which helps the organization reduce the risk of products getting outdated or storing products that are no longer usable. FIFO helps the organization reduce waste, ensure that it is not left with any unsold inventory, and mitigate the risk of holding such unsold inventory....

Disadvantages of FIFO

1. Higher Tax Liability: Under the FIFO method, the difference between profit and cost is wide, which can cause the organization to pay a higher tax. So, it is essential that, when using the FIFO method, the organization does not overstate its profits....

Difference between FIFO and LIFO

Basis FIFO LIFO Method The method is based on the First in, First Out rule. The method is based on the Last in First Out rule. Subject Matter The method is based on selling those items first that are stored for the longest. The method is based on selling those goods first that were bought recently. Ideal For This method is ideal for those items that are of a perishable nature. The method is ideal for those items that are of a homogeneous nature and do not have expiration criteria. Cost Reflection The FIFO method reflects historical costs. The LIFO method shows the current market condition. Result on Inventory The FIFO method shows an accurate value for ending inventory since older items have been consumed first, while the newest items show the current market prices. The LIFO method doesn’t provide an accurate inventory valuation as the valuation is much lower than inventory items at today’s prices. Result on COGS The FIFO method may result in lower costs of goods sold. The LIFO method may result in higher costs of goods sold. Effect on Tax The FIFO method can lead to paying a higher tax as the gap between profit and cost is larger. The LIFO method can appear to be a tax-saving method in certain jurisdictions Effect on Inventory Management The FIFO method helps to reduce inventory obsolescence. The LIFO method may result in inventory obsolescence....

Frequently Asked Questions (FAQs)

What does FIFO stand for?...