Understanding FIFO Inventory Valuation
There are many different inventory valuation methods, and it can be hard to understand them all. In this post, we will take a look at FIFO Inventory Valuation, and discuss the basics. Let’s get started!
What Is FIFO (First In, First Out)?
FIFO is a method of asset management and valuation. It operates under the assumption that the assets that are produced or acquired by a company first are sold, used, or disposed of first. Therefore FIFO Inventory Valuation means, First In (first items to be produced) First Out (First items to be sold).
FIFO assumes that the assets remaining in any given inventory are matched by the assets that have most been recently purchased or produced – it operates under the assumption that companies will always try to use, sell, or dispose of older products, due to obsolescence and other factors.
An Example Of FIFO Logistics
Let’s explain FIFO with a simple exercise. Let’s consider a company that has purchased 100 units of a product, called “Product A”. Each unit is worth $100. Then, they purchase 100 units of “Product B”. Each unit is worth $150.
Then, the company begins to resell these items. In a FIFO system, the first item resold will be assigned a value of $100 – whether it is product A or product B. This is because FIFO inventory assumes that you will always sell the oldest items (the first ones acquired) first!
Then, as soon as 100 items are sold (regardless of whether they are Product A or B), the value of the resold items will jump to $150 – because the system assumes that all of Product A has been resold.
Alternatives To FIFO
The most common alternative to FIFO is LIFO – Last In, First Out. This method operates on the opposite assumption – that your company will attempt to sell, use, or get rid of the newest items first.
Other alternatives include the “average cost” inventory method, where the total cost and number of items are averaged, and this is used for valuation.
Anyone of these systems can be used for inventory valuation, as long as they are used accurately and consistently.
Once again, thank you very much for reading our post. I hope it can help a little with your business.
PS: Here is a link, in case you are interested to read and explore our FIFO – The (First In – First Out) Add-on.
For FIFO and LIFO accounting, please, visit wikipedia here.
Have a great day and stay good.