Advantages of First In First Out (FIFO) Method

First In First Out – FIFO is an easy-to-understand accounting system with many benefits for businesses and owners. While LIFO, Last In First Out, is also easy to understand. In India, most businesses use either the weighted average method or the FIFO method, as it is easy to use and adaptable.

Advantages of FIFO

FIFO methods are easy to understand and can be easily adapted by any business, regardless of the nature of its business.

• The accounting system for FIFO is very simple as it records the prices of goods as they come in and enter those in the balance sheet according to those prices. Therefore, the documentation and paperwork for this method are also easy to adapt.
• Since older products are sold first, the latest products will always be in stock, keeping in mind the latest products in the business, making them trendy and up-to-date.
• Accounting is easy. Since the price reflects their true value, anyone can get the job done, so businesses don’t have to hire experts or Chartered Accountants to do the job, saving time and costs.
• Accuracy not only in terms of accounting and balance sheets but also in terms of tracking the stock of inventory that is sold and not sold.

Although, if the first-in-first-out method has several advantages, it also has some disadvantages. While this is not a hurdle, it’s just something you should consider when using a FIFO inventory accounting system.

Under the FIFO system, profits can sometimes be inflated because old prices for goods and services are taken into account. As a result, older goods cost more during periods of falling prices, increasing profits on the balance sheet. Although it may appear that profits are increasing, this only happens during the economic period, and one must keep in mind that profits will not be maintained for a longer period of time.

First In First Out Accounting Inventory Example

Although we have covered the First In First Out theory, the best way to understand this system is to look at it with an example and understand it with a few numbers.

Some retail stores use the FIFO method to track retail inventory on a first-come, first-served basis. They bought branded shirts worth INR 300 per shirt for a quantity of 1000 and branded jeans worth INR 500 for a quantity of 100. This is what the transactions look like

1000 Branded Shirts = INR 300 x 1000 = INR 3,00,000

100 Branded Jeans = INR 500 x 100 = INR 50,000

In the middle of the month, they added 500 branded shirts at INR 400 and 50 branded jeans at INR 700.

500 Branded Shirts = INR 400 x 500 = INR 2,00,000

50 Branded Jeans = INR 700 x 50 = INR 35,000

By the end of the month, they had sold 1,200 branded shirts and 120 branded jeans. But since they follow the First In First Out method for inventory management, the 1,000 branded shirts will be at INR 300, and the remaining 200 will be at the later cost of goods at INR 400.

The same goes for branded jeans. The first 100 will be at the first price of INR 500, and the remaining 20 will be at the later price of Rs 700. This is what the accounting and calculations for this transaction look like:

1000 Branded Shirts = INR 300 x 1000 = INR 3,00,000 [Old Stock]

200 Branded Shirts = INR 400 x 200 = INR 80,000 [New Stock]

100 Branded Jeans = INR 500 x 100 = INR 50,000 [Old Stock]

20 Branded Jeans = INR 700 x 20 = INR 14,000 [New Stock]

While it is possible to take and fill the quantity with the newest product, since they follow the First In First Out system, the earlier stock needs to be entirely over before switching to the newer stock. Therefore, while inventories may be the same, this should be reflected in prices and on the balance sheet or profit and loss statement.

That’s all one needs to know about the First In First Out, FIFO method.