What Is First In First Out (FIFO) Method ?
FIFO (First In First Out) is a method of inventory valuation in which first batch of materials (oldest stock) are issued or sold first and new lot (latest purchase) remains in the stock. This method is just opposite of LIFO (last in first out) method. In this method, value of the closing stock is determined on the basis of latest purchase price.
Benefits Or Advantages Of First In First Out (FIFO) Method
The main advantages of FIFO method of inventory valuation can be pointed out as follows:
1. Simple And Easy Method
FIFO is simple to operate and easy to understand. It does not required special mathematical or accounting knowledge to understand this method.
2. Widely Used Technique
It is the most popular , widely used and GAAP approved method of inventory valuation. Big companies prefer this method because it provides more accurate result than other methods.
3. Realistic Approach
FIFO is more realistic than LIFO method because in this method, value of stock represents the current market price.
4. Prevents Wastage And Obsolescence
In FIFO method, materials are issued on a chronological order, it means older items are sold first and newly purchased goods are stored. It helps to prevent wastage and obsolescence of materials.
5. Suitable For
It is suitable for perishable products having shorter life which cannot be stored for a long period.
6. No Manipulation Of Income
It is difficult to manipulate income like in LIFO because materials are sold at the old cost.
Drawbacks Or Disadvantages Of First In First Out (FIFO) Method
Major disadvantages Of FIFO can be pointed out as follows:
1. Overestimation Of Income
One of the main weak point of this system is that it overestimates income during inflation. It shows higher profit because of higher selling price and lower cost of production.
2. High Tax Liability
When the price of the product rises, it shows more profit because of less production costs which leads to increase in the tax liability of the firm.
Also Read:
Advantages And Disadvantages Of LIFO
Difference Between LIFO And FIFO
3. Cost Fluctuations
In this method, production costs fluctuate as per the fluctuations in the price of materials.
4. Difficult To Record
Because of frequent fluctuation in the price of materials, it is difficult to maintain record properly. It makes clerical work complex and increases the chance of errors.
5. Not Suitable
FIFO method is not appropriate if many lots of materials are acquired at different price in the same period.
Pros And Cons Of FIFO In Short
Pros:
- It is simple to maintain and easy to understand
- Provides more realistic results than LIFO
- It is most commonly used method
- It is approved By GAAP
- It discourages the manipulation of figures
Cons:
- It overestimates the income of the firm
- It increases the tax liability
- High chance of clerical errors
- It understates the cost of production
- Matching of current costs and current revenue is not possible
