What is the FIFO method? Difference between LIFO and FIFO
The FIFO method is one of the methods of managing goods as well as calculating cost of goods sold that is commonly used in many businesses today. With this principle, goods that are warehoused first will be exported first according to the time process. To better understand FIFO as well as how to manage goods according to FIFO principles, please follow the article below with 1C Vietnam.
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1. What is FIFO?
FIFO stands for First in, First out and is an inventory valuation method that assumes that goods produced or imported first will be sold, used or processed first. FIFO serves as both an accurate and easy way to calculate the value of ending inventory, as well as a suitable way to manage a business's inventory to save costs and bring benefits to customers.
1.1 Advantages
FIFO is a popular inventory costing method because it has many advantages, from proper inventory tracking to best serve customers to ensuring effective management by accounting software. Here are some outstanding advantages of FIFO:
- Accurate cost analysis: FIFO provides accurate information about the cost of inventory in a business at any given time. This method aligns a business's current costs with the actual flow of goods or inventory out of the business more accurately than any other method. This allows for more accurate cost accounting and real-time analysis if there is large inventory.
- Ease of use and application: When using the FIFO method, a business can easily apply the principles by managing inventory costs for the most recent purchases because each purchase is recorded in order. .
- Save time and money in calculating the exact cost of goods sold. Ensure timely provision of data for bookkeeping and management before exporting.
- Follow the natural flow of goods (sell pre-stocked products). This helps the cost of goods sold closer to the market value, making the indicators in the balance sheet more economically meaningful.
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1.2 Disadvantages
Besides the above advantages, FIFO still has certain limitations in some cases, specifically:
- During periods of inflation, using the FIFO method can overstate profits due to the difference between costs and revenue leading to a higher tax liability of the business thereby increasing cash outflow relative to tax expenses. .
- Although the FIFO method is easy to understand, it can sometimes become cumbersome when extracting information related to the cost of goods due to the large amount of data required.
- Accounting costs and the amount of work required increase for businesses that sell many types of products.
2. FIFO example
Below is a concrete example of how the FIFO principle is applied to calculate inventory prices. Suppose a new product model is about to be launched and clothing store X has pre-ordered 100 T-shirts at a price of 50,000 VND/piece in February 2023. Therefore, the total initial cost of inventory is VND 5,000,000.
After that, the store owner imported 60 more shirts at a price of 55,000 VND/piece and 65 shirts at a price of 60,000 VND/piece in the next 2 months. Then the total inventory is detailed in the following table:
Month | Quantity | Price (VND/piece) |
2 | 50 pcs | 50,000 |
3 | 55 pcs | 55,000 |
4 | 60 pcs | 60,000 |
In May, the store sold a total of 80 shirts. According to the FIFO principle, cost of goods sold is calculated as follows: 50x50,000 + 30x55,000 = 4,150,000 VND. The remaining 85 unsold shirts will be counted as inventory.
The store can rely on the cost of goods sold to calculate the store's profit that month by subtracting the cost of goods sold from the sales revenue.
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3. What businesses is the FIFO method often applied to?
FIFO is often used for businesses that produce and sell products with a short shelf life, are perishable (food, personal belongings, etc.) or goods with a short life cycle (short shelf life). page, technology, ...).
FIFO is suitable for businesses that sell goods for short-term use
4. What is the difference between LIFO and FIFO?
While FIFO refers to first in, first out, LIFO stands for Last in, First out, meaning last in, first out. In contrast to FIFO, LIFO assumes that the last inventory purchased is the first sold. Below is a detailed comparison table of the differences between LIFO and FIFO:
FIFO method | LIFO method | |
Nature | First in first out | Last in, first out |
Tax costs during inflationary periods | Low cost of goods sold leads to high profits, making tax payments higher | High cost of goods sold leads to low profits, making tax payments lower |
Ability to inventory obsolete products | Selling pre-stocked products reduces the risk of items becoming obsolete or expired | Selling products that were warehoused later increases the risk that previously imported products that have not yet been shipped become obsolete or expired. |
The value of unsold goods as costs increase | High | Short |
Hopefully the above article, 1C Vietnam has helped businesses better understand what FIFO is and the difference between FIFO and LIFO. From there, businesses can apply this method to calculate inventory prices effectively. If you need further advice on production management solutions, please contact 1C Vietnam immediately for more detailed information!
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