How does FIFO work?

Definition

FIFO is the inventory method that treats the oldest purchase costs as the ones that leave first. On the books, this is a cost-flow assumption, not a claim about which box a clerk actually grabbed.

Oldest invoice costs leave first when units sell. Newer costs stay on the inventory line.

The physical goods can move in any order. The method only decides which dollar amounts leave the inventory line.

Where it shows up

Balance Sheet: Related to the inventory line when older costs remain on hand.

P&L: Related to cost of goods sold, which uses the oldest costs first.

See also: Inventory Valuation · Cost Of Goods Sold · Inventory

When you look at your Balance Sheet, inventory sits with the other current assets. Under FIFO, that line usually holds the more recent purchase costs.

The Income Statement does not say "FIFO" on it. It shows cost of goods sold built from the oldest costs first.

If purchase prices are rising, FIFO tends to leave a higher inventory balance and a lower cost of goods sold. The two statements move together because every purchase dollar is either still on hand or already sold.

Cash does not care which cost layer you assigned. Cash moved when you paid the vendor, not when FIFO picked a layer.

How it works

You record each purchase at what you actually paid, including freight if that cost belongs with the goods. Those purchases stack as layers: oldest on the bottom, newest on top.

When you sell units, FIFO peels costs from the oldest layer first. That layer is used up before any newer cost is touched.

Whatever layers are left become the inventory balance. Those leftover costs are usually the ones from the most recent buys.

A physical count still matters. The count confirms how many units remain; FIFO only prices those units.

You apply FIFO to a class of goods and keep using it. The method is a standing rule, not a choice you remake each time a delivery arrives.

Landed costs that belong with a purchase stay with that layer. FIFO does not average them away; it keeps the layers intact until they sell.

Example

A produce stand buys lettuce in two drops. Monday's 50 heads cost $2 each ($100), and Wednesday's 50 heads cost $3 each ($150).

Over the next two days the stand sells 50 heads. Under FIFO, the Monday layer leaves first, even if a clerk grabbed a Wednesday head.

The sale of those 50 heads is recorded:

Debit: Cost of goods sold $100

Credit: Inventory $100

Cost of goods sold is $100, and inventory falls by $100. The remaining 50 heads stay on the Balance Sheet at the Wednesday cost of $150.

Assets are lower by the $100 that left. The P&L now holds that $100 as cost against the lettuce sales.

The oldest lettuce is the one the stand wants to sell first in real life too. FIFO matches that habit, which is why produce shops often find the method easy to explain.

Common mix-ups

FIFO is not a promise about which physical unit left the shelf. It is a rule for assigning cost, even if the newest head of lettuce was the one a customer took.

FIFO is not LIFO. LIFO would send the newest costs to cost of goods sold first and leave the older costs on the Balance Sheet.

FIFO is not a count of the stock. A count tells you how many heads remain; FIFO tells you which purchase costs those heads still carry.

Related terms

• Inventory Valuation: The method used to assign cost to units held and units sold.
• LIFO: An inventory method that assumes the newest units are sold first.
• Weighted Average Cost: An inventory method that spreads total cost evenly across all units on hand.
• Cost Of Goods Sold: The direct cost of the products sold during the period.
• Inventory: Goods held for sale or used to produce goods for sale.
• Gross Margin: Gross profit expressed as a percentage of revenue.
• Physical Inventory Count: A full hands-on count of stock used to correct the recorded balance.
• Landed Cost: The full cost of getting a purchased item to your door, including freight and duties.