FIFO (First In, First Out)
FIFO stands for First In, First Out, and it’s a method of inventory management and accounting where the first products that are acquired are the first ones to be sold or consumed.
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What is FIFO (First In, First Out)?
In different fields like computer science, inventory management, and accounting, FIFO is a commonly used concept. It’s simple – older items in a stock or queue are removed first. This principle helps ensure that goods go out in the order they came in. This is particularly important in industries with perishable goods’ shelf life, and tracking costs over time.
How Does FIFO Work?
Inventory Management
Businesses make use of FIFO so that they can sell their oldest items before newer ones. Over all others, this will mostly apply to perishable goods, whereby utilization of the oldest stock assists in reducing waste and spoilage.
Example: A milk delivery every week from a grocery shop means that the old stock will be sold first before displaying the new one. Such an arrangement ensures that the milk does not go bad before it is sold.
Accounting
FIFO is also used as a cost-flow assumption in accounting to determine the cost of goods sold (COGS) and ending inventory. For FIFO, COGS is calculated using the cost of the oldest inventory, while the ending inventory value is obtained by multiplying the cost of the most recent goods purchased by their quantity.
Example: If a company buys 100 units of a product at $10 each and then buys 100 more at $12 each, under FIFO, the first 100 units sold would be valued at $10 per unit. The same can be arranged for cryptocurrency.
Computer Science
In computer science, FIFO is used in data structures like queues, where the first data element added to the queue is selected for processing first. It helps when there are tasks arranged according to the time they came.
Example: In a printer queue, what gets printed first is what was sent to print first, ensuring all jobs are done in chronological order.
Benefits of Using FIFO
The use of FIFO has several benefits that help with inventory management and accounting issues, especially:
- Simplicity and transparency. FIFO is simple and easy to implement. It closely imitates the natural flow of inventory and can be easily understood or explained to some stakeholders.
- Accurate reflection of costs. In a period of rising prices, First In, First Out (FIFO) results in lower COGS by matching older, cheaper costs with current sales prices, leading to higher profits. This also means that taxes will be higher.
- Reduced obsolescence and spoilage. For businesses that deal with perishable goods or those with expiration dates on them, FIFO minimizes the risks of obsolescence and spoilage through the use of older stock first.
- Alignment with the physical flow of goods. In many businesses, like retail, which frequently sells newer stock as compared to old ones, FIFO matches the physical flow of goods.
These benefits provide insight for companies trying to determine whether FIFO is appropriate for managing their inventories and recording their accounting transactions.
Applications of FIFO Across Industries
Retail and Grocery
FIFO in this industry ensures that items like food and beverages, which have a very limited shelf life, are sold before they expire, reducing wastage while ensuring freshness in products.
Manufacturing
The oldest materials get used first by companies in the manufacturing of goods to ensure the prevention of risks involving expired or outdated materials that can be wasted during the production process.
Pharmaceuticals
The pharmaceutical industry uses FIFO to manage drugs and other medical supplies so that products don’t go past their expiration dates and lead to the administration of expired medicines.
Warehousing and Logistics
In warehousing and logistics, where cost reduction and product quality are determined by efficient inventory management, FIFO is vital. By being dispatched in the same sequence as they are received, space utilization is enhanced while handling time is reduced.
Food and Beverage
Efficiently using FIFO systems assists the food and beverage industry in maintaining product freshness as well as safety, which contributes to customer satisfaction levels and compliance with health regulations.
FAQ
What does FIFO mean in inventory management?
Inventory management’s FIFO is a method where the first items added to inventory are the first ones sold or used, controlling obsolescence and spoilage.
How will the financial statement be impacted by FIFO?
FIFO affects financial statements by determining the cost of goods sold (COGS) and the ending inventory value. In times of rising prices, it generally results in lower COGS, leading to higher profits and tax liabilities.
Why is FIFO important in the food industry?
FIFO guarantees that older products are sold before they expire so that product freshness will be maintained while waste will be decreased.
What other methods can be used instead of FIFO?
Some alternatives to FIFO are LIFO (Last In First Out), where the newest stock is sold first, and the Weighted Average Cost method, which averages all costs for each item in the inventory.
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