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FIFO Inventory Method - Material Cost, Cost Accounting Video Lecture | Cost Accounting - B Com
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FAQs on FIFO Inventory Method - Material Cost, Cost Accounting Video Lecture - Cost Accounting - B Com
| 1. What is the FIFO inventory method? |  |
Ans. The FIFO (First-In, First-Out) inventory method is a cost accounting method used to calculate the value of inventory by assuming that the first items purchased or produced are the first ones to be sold. This means that the cost of the oldest inventory is assigned to the cost of goods sold, while the cost of the most recent inventory is assigned to ending inventory.
| 2. How does the FIFO method determine the cost of goods sold and ending inventory? | |
Ans. The FIFO method determines the cost of goods sold by using the cost of the oldest inventory first. This means that the cost of the earliest purchases or production is matched with the revenue from the corresponding sales. The cost of goods sold is then calculated by multiplying the quantity sold by the cost of the oldest inventory items. The cost of ending inventory is determined by using the cost of the most recent inventory items, which remain unsold.
| 3. What are the advantages of using the FIFO inventory method? | |
Ans. The advantages of using the FIFO inventory method include:
- It provides a more accurate representation of the current value of inventory, as it assigns the most recent costs to ending inventory.
- It is easy to understand and apply, making it a popular choice for many businesses.
- It is more suitable for industries where the cost of inventory tends to increase over time, such as in inflationary periods.
- It results in a higher net income during periods of inflation, as the older, lower-cost inventory is assigned to the cost of goods sold.
| 4. Are there any limitations or disadvantages of using the FIFO inventory method? | |
Ans. Yes, there are some limitations or disadvantages of using the FIFO inventory method, such as:
- It may not reflect the actual physical flow of inventory in certain situations, especially if the business uses different storage locations or handling methods.
- It may not accurately represent the cost of goods sold during periods of deflation, as the older, higher-cost inventory is assigned to the cost of goods sold.
- It can result in higher income taxes during periods of inflation, as the higher net income generated by the method may lead to higher tax obligations.
- It requires a detailed record-keeping system to accurately track the cost of each inventory item purchased or produced.
| 5. How does the FIFO method impact financial statements and ratios? | |
Ans. The FIFO method can impact financial statements and ratios in several ways, including:
- It can result in a higher value of ending inventory, which in turn increases the value of assets on the balance sheet.
- It can lead to a higher net income on the income statement, as the cost of goods sold is based on older, lower-cost inventory items.
- It can affect the calculation of inventory turnover ratio, as the cost of goods sold is based on the oldest inventory items and may not accurately reflect the current inventory turnover rate.
- It can impact the calculation of gross profit margin, as the cost of goods sold is based on older, lower-cost inventory items, which may result in a higher gross profit margin.
Text Transcript from Video
in this video we're going to talk about
fifl which means first-in first-out and
FIFO is what we call an inventory
costing assumption and what we mean by
that is that when we have a certain
number of units that we've purchased so
we have our inventory over here and we
actually go and make a sale of that
inventory we sell some of it then we
have to decide okay which units are we
actually going to place in the cost of
goods sold and which in which units are
going to end up in ending inventory and
this will be a little bit easier to
understand in the context of an example
so let's say that you have a t-shirt
company you sell custom t-shirts and and
let's say that you end up selling 250
t-shirts you sell 250 t-shirts now this
is all the exact same type of t-shirt so
you sell 250 of your best-selling
t-shirt and that t-shirt is exactly the
same all 250 are exactly the same so you
look in your your inventory you look at
your purchases of all the t-shirts that
you have and you have to say okay well
now how do i compute my cost of goods
sold and what's my ending inventory I I
going to be because look you've
purchased here's there's the amount of
units that you've purchased you've
purchased you purchased 200 then 150 and
then 225 on three different dates so you
have to go ahead and say ok well I've
sold now 250 shirts but I've got a lot
more that I've actually purchased than
250
so which 250 did I sell because I sold
them or I bought them excuse me at
different prices right the ones that I
bought on March 1st I bought 200
t-shirts for $10 each and then on March
16th I went and bought 150 shirts for
$12 so now I have to say okay well now
that I've sold these t-shirts right you
remember we're going to be making an
entry a journal entry about cost of
goods sold we're going to be reducing
our inventory we've got to do these
different things
but we don't know which of these units
it was that that is comprising this 250
if we did know if we knew specifically
which 250 we sold we could use what was
called the specific identification
method and say okay here are the ones
that we sold on these dates and this is
what they cost but we know when we buy
our when we buy our t-shirts when we got
purchases let's just say we take all
these t-shirts and we just throw them in
one big pile so we just got one big pile
of inventory and so when we sell the 250
we don't know which ones they were that
we actually sold it could have been any
of these so that's why we make an
assumption we make a cost flow
assumption to tell us which units we're
going to assume it that actually help us
compute cost of goods sold and the
ending inventory so in this case because
we're using FIFO let me just scroll down
a bit because we're using FIFO we're
going to say first-in first-out
and what does that mean that means that
the first units purchased are going to
be the first ones that go to cost of
goods sold so we sold we sold 250 so the
first n what are the first n well march
first those are the first units we
purchased the first n are going to be
the first out so these are going to go
to cost of goods sold all right so we
got 200 units there but we've still got
we've just gotten our 50 we need to
account for so what do we do we say okay
well out of this 150 that we've got here
50 of those units are also going to go
to cost of goods sold so we've got 50
here and then we've got the full 200
here are all going to be cost of goods
sold right so the first units we've
purchased are going out so let's compute
our cost of goods sold now we've got
this 200 as those were the first end
they're going out now and the price per
unit was $10 a t-shirt so we're going to
have 200
times $10 but remember that we sold 250
t-shirts and this is just 200 so we had
to take another 50 out of here
out of that March 16th purchase so we go
with the 50 from that date and then we
multiply that by the $12 okay so now
this is going to give us so we've got
2,000 here and then we've got 600 this
is 600 so that gives us 2600 so that
would be our cost of goods sold under
the FIFO costing assumption but now we
say okay well what what would be the
ending inventory let me just write it
over here a little more space ending
inventory right well if we looked at the
balance sheet after this after this all
took place what would the balance sheet
show as our inventory I'll just just
change colors here so now we say okay
well we already took 50 out of here
right so that that really leaves us now
in terms of ending inventory we're going
to have a hundred they're right in
ending inventory and this hold 225 we
didn't mess with that right that didn't
go to cost of goods sold at all so all
225 of those units are also going to be
in ending inventory so we've got the
hundred that we didn't put the cost of
goods sold here and then we got the 225
that that we didn't touch so just bring
that down now we'll do the calculations
for ending inventory so we've got the
100 and now we look what price do those
go at well they we bought those at $12
$12 a unit so now we're going to have
that times 12 and then we've got the 225
so those two hundred and twenty five
units what price did we have per unit we
had 16 so we're going to multiply those
those 225 by the 16 and that's going to
give us we have here we are going to
have 1200 is from this portion and then
we've got 3,600
3,600 from the bottom and so that's
going to give us that's going to give us
4,800 will be our ending inventory now
just one final note in a period of
rising prices which is what we have here
right we have over time the price we're
paying for the shirts is getting more
expensive right it went from ten to
twelve to sixteen dollars and that often
mimics the real world where we have
rising prices right there's inflation
and so in such cases FIFO doesn't do a
good job matching current revenue with
current costs because the things that
are going to cost of goods sold under
this FIFO inventory inventory costing
assumption are the first units right so
this when we actually got the cost of
goods sold here it's including mostly
these $10 $10 units right from the
beginning because that's first in right
first in first out but the price we're
actually paying the most relevant price
the price that's what we have to pay for
shirts right now around the time where
we actually make the sale the current
cost is actually most recent classes is
quite a bit more expensive sixteen
dollars so in this case because there's
rising prices FIFO doesn't do the best
job matching the the sales price with
what the the current price to purchase
the t-shirt will
fifl which means first-in first-out and
FIFO is what we call an inventory
costing assumption and what we mean by
that is that when we have a certain
number of units that we've purchased so
we have our inventory over here and we
actually go and make a sale of that
inventory we sell some of it then we
have to decide okay which units are we
actually going to place in the cost of
goods sold and which in which units are
going to end up in ending inventory and
this will be a little bit easier to
understand in the context of an example
so let's say that you have a t-shirt
company you sell custom t-shirts and and
let's say that you end up selling 250
t-shirts you sell 250 t-shirts now this
is all the exact same type of t-shirt so
you sell 250 of your best-selling
t-shirt and that t-shirt is exactly the
same all 250 are exactly the same so you
look in your your inventory you look at
your purchases of all the t-shirts that
you have and you have to say okay well
now how do i compute my cost of goods
sold and what's my ending inventory I I
going to be because look you've
purchased here's there's the amount of
units that you've purchased you've
purchased you purchased 200 then 150 and
then 225 on three different dates so you
have to go ahead and say ok well I've
sold now 250 shirts but I've got a lot
more that I've actually purchased than
250
so which 250 did I sell because I sold
them or I bought them excuse me at
different prices right the ones that I
bought on March 1st I bought 200
t-shirts for $10 each and then on March
16th I went and bought 150 shirts for
$12 so now I have to say okay well now
that I've sold these t-shirts right you
remember we're going to be making an
entry a journal entry about cost of
goods sold we're going to be reducing
our inventory we've got to do these
different things
but we don't know which of these units
it was that that is comprising this 250
if we did know if we knew specifically
which 250 we sold we could use what was
called the specific identification
method and say okay here are the ones
that we sold on these dates and this is
what they cost but we know when we buy
our when we buy our t-shirts when we got
purchases let's just say we take all
these t-shirts and we just throw them in
one big pile so we just got one big pile
of inventory and so when we sell the 250
we don't know which ones they were that
we actually sold it could have been any
of these so that's why we make an
assumption we make a cost flow
assumption to tell us which units we're
going to assume it that actually help us
compute cost of goods sold and the
ending inventory so in this case because
we're using FIFO let me just scroll down
a bit because we're using FIFO we're
going to say first-in first-out
and what does that mean that means that
the first units purchased are going to
be the first ones that go to cost of
goods sold so we sold we sold 250 so the
first n what are the first n well march
first those are the first units we
purchased the first n are going to be
the first out so these are going to go
to cost of goods sold all right so we
got 200 units there but we've still got
we've just gotten our 50 we need to
account for so what do we do we say okay
well out of this 150 that we've got here
50 of those units are also going to go
to cost of goods sold so we've got 50
here and then we've got the full 200
here are all going to be cost of goods
sold right so the first units we've
purchased are going out so let's compute
our cost of goods sold now we've got
this 200 as those were the first end
they're going out now and the price per
unit was $10 a t-shirt so we're going to
have 200
times $10 but remember that we sold 250
t-shirts and this is just 200 so we had
to take another 50 out of here
out of that March 16th purchase so we go
with the 50 from that date and then we
multiply that by the $12 okay so now
this is going to give us so we've got
2,000 here and then we've got 600 this
is 600 so that gives us 2600 so that
would be our cost of goods sold under
the FIFO costing assumption but now we
say okay well what what would be the
ending inventory let me just write it
over here a little more space ending
inventory right well if we looked at the
balance sheet after this after this all
took place what would the balance sheet
show as our inventory I'll just just
change colors here so now we say okay
well we already took 50 out of here
right so that that really leaves us now
in terms of ending inventory we're going
to have a hundred they're right in
ending inventory and this hold 225 we
didn't mess with that right that didn't
go to cost of goods sold at all so all
225 of those units are also going to be
in ending inventory so we've got the
hundred that we didn't put the cost of
goods sold here and then we got the 225
that that we didn't touch so just bring
that down now we'll do the calculations
for ending inventory so we've got the
100 and now we look what price do those
go at well they we bought those at $12
$12 a unit so now we're going to have
that times 12 and then we've got the 225
so those two hundred and twenty five
units what price did we have per unit we
had 16 so we're going to multiply those
those 225 by the 16 and that's going to
give us we have here we are going to
have 1200 is from this portion and then
we've got 3,600
3,600 from the bottom and so that's
going to give us that's going to give us
4,800 will be our ending inventory now
just one final note in a period of
rising prices which is what we have here
right we have over time the price we're
paying for the shirts is getting more
expensive right it went from ten to
twelve to sixteen dollars and that often
mimics the real world where we have
rising prices right there's inflation
and so in such cases FIFO doesn't do a
good job matching current revenue with
current costs because the things that
are going to cost of goods sold under
this FIFO inventory inventory costing
assumption are the first units right so
this when we actually got the cost of
goods sold here it's including mostly
these $10 $10 units right from the
beginning because that's first in right
first in first out but the price we're
actually paying the most relevant price
the price that's what we have to pay for
shirts right now around the time where
we actually make the sale the current
cost is actually most recent classes is
quite a bit more expensive sixteen
dollars so in this case because there's
rising prices FIFO doesn't do the best
job matching the the sales price with
what the the current price to purchase
the t-shirt will
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