FIFO, or First In First Out, is an asset management method. In this blog post, we will explore all you need to know about FIFO, including how to use it.
For taxing requirements in FIFO, it is assumed that the first good purchased is considered sold in the income statement. The rest of the inventory is matched to determine which ones are sold. In FIFO, you must dispose of the assets you purchased first. The rest of the inventory items are considered to have been purchased later. Alternatively, another accounting method is Last In First Out (LIFO), in which the last purchased product is sold first.
In an inflation market FIFO method brings in a higher income than the LIFO method as the goods are sold with older costs. FIFO is used to assume the cost of developing a product. Each product, from its inception until its purchase, comes with some associated development costs. This cost is categorized as an expense. In the FIFO method, the cost of products developed first is preferred.
When Should You Use FIFO
The FIFO method is used to assume the manufacturing cost. The cost associated with developing a product must be entered as an expense. Depending on the manufacturing expense, you must decide the product cost. In the FIFO method, it is assumed that the product you manufacture first is entered into the inventory first. It helps in reducing the total cost of your inventory.
The FIFO method is vital for businesses that deal with perishable goods. They will always have to ensure that the product they enter first leaves to retain the freshness and avoid the good getting spoiled. Another important business is those who need to closely monitor their inventories. The FIFO method avoids overstocking or understocking of products. In areas and businesses where companies must pay taxes on the inventory, the FIFO method is critical as it calculates the oldest and most expensive goods sold first, thus minimizing the tax liability.
Advantages of FIFO
The FIFO method is popular for accounting inventories across the world. It can analyze the cost of your inventory accurately. It matches the flow of products with current market costs fairly accurately to give you an idea of your inventory cost at any time. The FIFO method is compatible with most of the software. In fact, most accounting software uses the FIFO method for an accurate real-time inventory analysis. To customize your valuation method, buy premium rate software or outsource your accounting requirement to a third-party agent.
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The FIFO method is easy to implement as all you require to do is record the most recent inventory in order as you receive them. The cost of some products tends to increase with time. Since in this method you sell the older products first, you can sell them at a higher price than what is available in the current market. This increases the revenue of your business. These advantages make the FIFO method highly popular across all industries.
Calculation of FIFO
The idea behind FIFO is that a company should sell its oldest product first so that the product is still useful. The cost assigned to each product depends on when each product is used. In the FIFO method, it often depends on which product came first. To calculate FIFO, you must first add the cost of the products you sold in your inventory. For example, if you have sold 10 products, add the price of those 10 products. This gives you the total cost of the product that you have sold. This amount varies depending on which valuation method you have chosen. Often the type of valuation method used depends on the industry you are in.
Best Practices: FIFO
TAs with anything in life, if you select and implement the FIFO valuation method, you must use it correctly to extract maximum benefits. Some of the best practices are the following:
Ensure that you use software for accounting. Almost all accounting software that can handle inventory management can use FIFO automatically. Doing so will ensure that you analyze cost more effectively and easily.
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Remember the flow of your inventory products to ensure you utilize the FIFO method optimally. The product that you add first also needs to be sold first. This is especially true for perishable products whose quality deteriorates more than if kept shelved.
The last best practice is adding the products to your inventory the same day you receive them. This will ensure no mismatch between the product in your warehouse and the one you enter into the system. When you enter the product into your accounting system, add their respective prices so that the software automatically calculates the price as and when they are sold.
FIFO or LIFO
LIFO is another valuation method that is the opposite of the FIFO method. In this, the product which enters the inventory system the last is sold first. LIFO can only be implemented legally by businesses that are based in the United States of America. In the LIFO method, since the product added to the inventory last is sold first, it can impact the company’s revenue. While the LIFO method lets the companies pay less than usual income taxes, the FIFO method lets the companies calculate these income taxes more accurately. LIFO is used in the automobile industry, where it makes logical sense for the latest product to be sold first.
Conclusion:
The FIFO method is quite comprehensible and can be implemented easily. It follows the regular inventory process. It more accurately calculates your current inventory value than the LIFO method. Moreover, in some jurisdictions, the FIFO method is mandatory.
The FIFO method is quite comprehensible and can be implemented easily. It follows the regular inventory process. It more accurately calculates your current inventory value than the LIFO method. Moreover, in some jurisdictions, the FIFO method is mandatory.
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Companies can decide on the valuation method used depending on the type of products sold. The choice they make will directly impact their financial status and revenue. The FIFO method is widely used across multiple countries and is considered more transparent than the LIFO method. However, you should select your method depending on several factors, including location, the product you manufacture, and the feasibility of implementing each valuation method.
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