FIFO, which stands for "first-in-first-out," is an inventory costing method which assumes that the first items placed in inventory are the first sold. Thus, the inventory at the end of a year consists of the goods most recently placed in inventory. FIFO is one method used to determine Cost of Goods Sold for a business .
Here is how inventory cost is calculated using the FIFO method:
Assume a product is made in three batches during the year. The costs and quantity of each batch are:
- Batch 1: Quantity 2,000 pieces, Cost to produce $8000
- Batch 2: Quantity 1500 pieces, Cost to produce $7000
- Batch 3: Quantity 1700 pieces, Cost to produce $7700
Then calculate the unit costs for each batch:
- Batch 1: 8000/2000 = 4
- Batch 2: 7000/1500 = 4.667
- Batch 3: 7700/1700 = 4.529
- The first 2000 units sold from the first batch cost $4 per unit.
- The next 1500 units sold from the second batch cost $4.667 per unit.
- And the last 500 units sold from the third batch cost $4.529.