Inventory FIFO: A Complete Guide to the First-In, First-Out Method

Keywords: FIFO inventory method, First-In First-Out, inventory valuation, inventory accounting, FIFO vs LIFO, COGS, financial reporting, inventory management, GAAP, IFRS

Introduction

Inventory is one of the most valuable assets for product-based businesses. How a company values and tracks inventory directly affects its cost of goods sold (COGS), tax liabilities, and profitability. One of the most widely used methods for inventory accounting is FIFO — First-In, First-Out.

In this blog, we’ll explore the FIFO inventory method in detail: what it is, how it works, real-world examples, its impact on financial reporting, and comparisons with other methods like LIFO and weighted average cost.

What is FIFO (First-In, First-Out)?

FIFO (First-In, First-Out) is an inventory valuation method where the oldest inventory items purchased or produced are assumed to be sold first. It reflects the natural physical flow of inventory — especially for perishable goods — and aligns with accounting standards like GAAP and IFRS.

Key Concepts of FIFO:

• The earliest costs are assigned to COGS.
• The newest costs remain in ending inventory.
• FIFO reflects current market value in the balance sheet better than LIFO.
• Common in industries with perishable or time-sensitive goods.

How FIFO Works: Step-by-Step

Let’s break FIFO down with an easy-to-follow example.

Example: FIFO Inventory Calculation

ABC Store buys and sells T-shirts. Here’s a summary of its purchases in January:

• Jan 1: Bought 100 units @ $10 = $1,000
• Jan 10: Bought 100 units @ $12 = $1,200
• Jan 15: Bought 100 units @ $14 = $1,400

Total Units Available: 300 units
Total Inventory Cost: $3,600

Jan 20: Sold 150 units.

FIFO COGS Calculation:

• First 100 units from Jan 1 @ $10 = $1,000
• Next 50 units from Jan 10 @ $12 = $600
  Total COGS = $1,600

Ending Inventory Calculation:

• Remaining 50 units from Jan 10 @ $12 = $600
• 100 units from Jan 15 @ $14 = $1,400
  Ending Inventory = $2,000

Why Businesses Use FIFO

FIFO offers several operational and financial advantages, particularly in periods of inflation or stable pricing.

1. Simplicity and Logic

FIFO aligns with the natural flow of goods. Businesses often sell older stock first, especially in retail, food, and manufacturing.

2. Higher Net Income During Inflation

When prices are rising, the oldest (cheaper) inventory is used in COGS, leading to:

• Lower COGS
• Higher gross profit
• Higher taxable income

3. Accurate Balance Sheet Valuation

Since the newest (higher-priced) inventory remains in stock, the inventory balance on the balance sheet reflects more current prices.

FIFO vs LIFO vs Weighted Average Cost

LIFO (Last-In, First-Out):

• Assumes latest inventory sold first.
• Results in higher COGS and lower taxable income.
• Not allowed under IFRS.

Weighted Average Cost:

• Averages out the cost of inventory units.
• Simpler, but less reflective of specific price trends.

Impact of FIFO on Financial Statements

1. Income Statement

• COGS is based on older (cheaper) inventory costs.
• Gross Profit and Net Income are higher in times of inflation.

2. Balance Sheet

• Inventory Valuation is based on recent purchases, reflecting current market value more accurately.

3. Cash Flow

• Due to higher net income, FIFO may lead to higher tax payments, reducing cash flow.

When FIFO Is Most Useful

Industries That Commonly Use FIFO:

• Retail and E-commerce (clothing, electronics)
• Grocery and Food Services
• Pharmaceuticals
• Manufacturing
• Consumer Packaged Goods (CPG)

These businesses often sell items with expiration dates or frequent style/model updates, making FIFO a practical choice.

FIFO and Accounting Standards (GAAP and IFRS)

• FIFO is accepted under both GAAP (U.S.) and IFRS (International).
• LIFO is prohibited under IFRS, making FIFO the preferred choice for multinational companies.
• FIFO helps ensure consistency in international reporting, especially for global supply chains.

Real-World Example: Walmart

Walmart, one of the largest retailers globally, uses FIFO to manage its vast inventory across stores. By selling older stock first, Walmart reduces waste, manages markdowns efficiently, and keeps its inventory valuation aligned with current costs, critical for accurate financial planning and reporting.

Advantages of FIFO

1. Simple and Logical

Easy to understand and implement for most businesses.

2. Accurate Inventory Valuation

Inventory reflects current replacement costs on the balance sheet.

3. Higher Profits During Inflation

Older inventory costs yield lower COGS, boosting profit margins.

4. Globally Accepted

Complies with both GAAP and IFRS, enabling consistent global reporting.

Disadvantages of FIFO

1. Higher Tax Liability

Higher profits during inflation lead to larger tax bills.

2. Distorted COGS in Volatile Markets

When prices fluctuate drastically, FIFO may not reflect the actual cost of goods sold.

3. Risk of Obsolescence

Newer, high-cost items may stay in inventory longer, increasing the risk of unsellable stock.

Automating FIFO Inventory Management

Manually tracking FIFO can be error-prone, especially for businesses with high inventory turnover. Many companies use inventory management systems or ERP software that supports FIFO automatically.

Popular Software with FIFO Capabilities:

• QuickBooks Online Advanced
• NetSuite ERP
• Zoho Inventory
• Fishbowl Inventory
• SAP Business One

These platforms automate inventory flow, integrate with accounting modules, and generate FIFO-based reports for auditing and tax preparation.

FIFO in Tax Reporting

In the U.S. (GAAP-Compliant):

FIFO is acceptable for financial reporting and tax reporting. However, if you use FIFO for financials and switch to LIFO for taxes, you must follow the LIFO conformity rule.

Globally (IFRS-Compliant):

FIFO is often the only allowable method under International Financial Reporting Standards, simplifying reporting across countries.

Financial Ratios Affected by FIFO

1. Gross Profit Margin

Higher under FIFO when input costs are rising.

2. Inventory Turnover Ratio

Can be distorted if newer inventory remains unsold.

Formula:

Inventory Turnover = COGS / Average Inventory

3. Current Ratio

Higher inventory values increase current assets, improving liquidity ratios.

Conclusion

The FIFO (First-In, First-Out) method remains one of the most effective and widely accepted inventory valuation strategies. It simplifies the flow of goods, supports accurate financial reporting, and is compliant with global accounting standards.

Whether you’re a small business selling consumer goods or a large enterprise with complex logistics, adopting FIFO can bring clarity, efficiency, and compliance to your inventory management.

For optimal results, pair FIFO with inventory management software and strong internal controls — this ensures that your financial data remains reliable, and your business remains competitive.

References

1. Investopedia. First In, First Out (FIFO)
2. QuickBooks. FIFO Inventory Management
3. IFRS.org. IFRS Standards on Inventory Accounting
4. Oracle NetSuite. Inventory Costing Methods
5. U.S. GAAP. Accounting Standards Codification (ASC) 330 – Inventory