What Is FIFO? First In, First Out Inventory Method

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FIFO (first in, first out) is an inventory costing method that assumes the oldest units a business bought or produced are the first ones sold. Under FIFO, the earliest purchase costs go to cost of goods sold (COGS), and the most recent purchase costs stay in ending inventory. FIFO is accepted under U.S. generally accepted accounting principles (GAAP) and under International Financial Reporting Standards (IFRS). It is one of several cost flow assumptions a company can choose, and the choice changes reported profit, inventory value and taxes whenever purchase prices change.

How FIFO works

A business that buys the same item at different prices holds inventory in cost layers: each purchase is a layer with its own unit cost. When units are sold, the accounting system has to decide which layer’s cost moves from the balance sheet to the income statement as an expense. FIFO answers that by always drawing from the oldest layer first. Once a layer is used up, the next oldest layer is used.

Two balances come out of this process:

1. Cost of goods sold, built from the oldest costs.
2. Ending inventory, built from the newest costs still on hand.

Because the two figures together always equal the total cost of goods available for sale, any cost that does not go to COGS stays in inventory. The method only decides how that total is split.

FIFO is a cost assumption, not a shelf rule

FIFO in accounting does not require the oldest physical item to leave the warehouse first: a company can stack new stock in front of old stock and still use FIFO for its books. Many sellers of perishable goods, such as grocers, do rotate stock so older items sell first, and FIFO matches that flow closely. A related warehouse rule, FEFO (first expired, first out), ships by expiry date rather than arrival date. FEFO is a stock-handling practice, not a costing method.

How to calculate FIFO

1. List each purchase layer in date order with its units and unit cost, starting with beginning inventory.
2. Take the number of units sold in the period.
3. Assign those units to the oldest layer first, then the next oldest, until all sold units are covered.
4. Add the costs assigned in step 3. That total is COGS.
5. The units left in the newest layers, at their own unit costs, make up ending inventory.

You can check the result with the standard inventory identity:

COGS = Beginning inventory + Purchases − Ending inventory

A useful property of FIFO is that it gives the same answer whether the business updates inventory after every sale (a perpetual system) or only at period end (a periodic system). The oldest layers are consumed first either way. LIFO and average cost can produce different figures under the two systems.

FIFO example

Hypothetical example for illustration. A retailer makes two purchases of the same product:

• Purchase 1: 100 units at $10 = $1,000
• Purchase 2: 100 units at $15 = $1,500
• Total available for sale: 200 units costing $2,500

First sale: 60 units. All 60 come from the $10 layer.

• COGS: 60 × $10 = $600
• Remaining inventory: 40 units at $10 ($400) plus 100 units at $15 ($1,500) = $1,900

Second sale: 50 units. The 40 remaining $10 units are used first, which empties the first layer. The other 10 units come from the $15 layer.

• COGS: (40 × $10) + (10 × $15) = $400 + $150 = $550
• Remaining inventory: 90 units at $15 = $1,350

For both sales combined, FIFO COGS is $1,150 and ending inventory is $1,350, which add up to the $2,500 total cost.

The same purchases under LIFO and average cost

Using the same 200 units and 110 units sold, and assuming a periodic system:

• LIFO: the 110 units sold come from the newest layer first: (100 × $15) + (10 × $10) = $1,600 COGS. Ending inventory is 90 units at $10 = $900.
• Weighted average cost: $2,500 ÷ 200 units = $12.50 per unit. COGS is 110 × $12.50 = $1,375. Ending inventory is 90 × $12.50 = $1,125.

Now assume the retailer sold all 110 units at a hypothetical $25 each, for revenue of $2,750. Gross profit would be $1,600 under FIFO, $1,375 under average cost and $1,150 under LIFO. The physical goods and the cash spent are identical in all three cases; only the allocation of cost between the income statement and the balance sheet differs.

How FIFO affects financial statements

When costs rise, older layers are cheaper. FIFO sends those cheaper costs to COGS, so gross profit and net income are higher than under LIFO or average cost. The newer, more expensive units remain on the balance sheet, so the inventory asset is larger. Higher reported income also means higher income tax where taxable income follows the same method.

When costs fall, the effect reverses: FIFO expenses the older, more expensive layers, so COGS is higher and reported profit is lower than under LIFO.

This is why FIFO profit during inflation partly reflects holding gains: some of the margin comes from selling goods that cost less than it would cost to replace them now. Analysts comparing companies that use different methods often adjust for this, and U.S. companies that use LIFO disclose a LIFO reserve, the difference between their inventory at LIFO and what it would be under FIFO.

FIFO vs. LIFO vs. other methods

LIFO is the mirror image of FIFO: the most recent costs go to COGS first and the oldest costs stay in inventory, which can leave inventory on the balance sheet at costs that are years out of date.

Weighted average cost assigns every unit the same cost, calculated by dividing the total cost of goods available for sale by the total units available. Its profit and inventory figures land between FIFO and LIFO when prices move in one direction.

Specific identification tracks the actual cost of each individual item. It suits businesses selling distinct, high-value items, such as vehicles, jewelry or custom equipment, where each unit can be identified. For large volumes of interchangeable goods, a cost flow assumption like FIFO or average cost is used instead.

Rules that govern FIFO

• U.S. GAAP permits FIFO, LIFO, weighted average cost and specific identification. Inventory measured using FIFO or average cost is carried at the lower of cost and net realizable value, so if goods lose value (damage, obsolescence, falling selling prices), the FIFO cost is written down.
• IFRS permits FIFO, weighted average cost and specific identification, and prohibits LIFO.
• U.S. tax: a company that elects LIFO for tax purposes must also use LIFO in its financial reports to shareholders (the LIFO conformity rule). FIFO carries no such restriction.
• Consistency: a company is expected to apply its chosen method consistently. Switching methods is a change in accounting principle that must be justified and disclosed, and changing the method for U.S. tax purposes generally requires filing for IRS approval.

FIFO in investing

FIFO also applies to securities. When you sell part of a stock or fund position bought in several lots at different prices, the cost basis of the shares sold determines your capital gain or loss, and under FIFO the shares bought earliest count as sold first. In the U.S., FIFO is the default for stock unless you specifically identify which lots you are selling (mutual fund shares can also use average cost).

The trade-off mirrors inventory. If a position has risen steadily, the oldest lots usually have the lowest cost basis, so FIFO realizes the largest gain. Those older lots may also qualify for long-term capital gains treatment if held more than a year.

Advantages and limitations of FIFO

Advantages

• Simple to understand and apply, with results that are hard to manipulate by timing purchases.
• Matches the physical flow of goods for many businesses, especially perishables.
• Accepted under both U.S. GAAP and IFRS, which helps companies that report in several jurisdictions.

Limitations

• In rising-price periods, older costs are matched against current selling prices, so margins can look stronger than the business could sustain if it had to restock at today’s prices.
• For businesses whose goods do not physically move oldest first, FIFO is an assumption rather than a description of what happened.

FAQs

The Bottom Line

FIFO matters to business owners choosing an inventory method, to analysts comparing companies that use different methods, and to investors selling shares bought in several lots. When prices rise, FIFO reports higher profit, a larger inventory balance and higher taxes than LIFO, partly from holding gains. Companies reporting under IFRS cannot use LIFO, so FIFO or average cost is the practical choice for them.