First-In, First-Out (FIFO)

This method is based on the assumption, that cost should be charged to revenue in the order in which they are incurred, that is, first units received are the first ones to be sold or the units sold in the order in which they were acquired. The flow of costs is presumed to be the same as usual flow of goods. The ending-inventory is therefore assumed to be consisting of goods most recently purchased. In sum, FIFO assigns the cost of the earliest units acquired to the withdrawals (issues) and the cost of the most recent acquisition to the ending inventory. The FIFO formula assumes that the items of inventories which were purchased or produced first are consumed or sold first and consequently items remaining in inventory at the end of the period are those most recently purchased or produced. This is cost-flow assumption is inline with the good business practice to disposing goods in the order of their acquisition especially in the case of perishable goods and items in which style or model changes are frequent i.e., items that deteriorate or become obsolete. To the extent that this is the case, the FIFO method achieves the results similar to those obtained by specific identification method. Since FIFO assumes a cost-flow which is parallel to the actual physical-flow-of goods, it affords little opportunity for profit manipulations; assignment of costs against revenue is determined by the order in which costs are incurred. It must be kept in mind that this assumption of cost flow or goods flow need not be true as a physical fact. It relates only to the method of accounting and not to actual physical movement of the goods.

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