What Companies Use the FIFO Method of Accounting?

Companies must account for the cost of goods sold and the value of inventory they hold. This accounting is essential for calculating a business’s profitability and asset value. Various methods exist, each with distinct implications for financial reporting.

Fundamentals of FIFO

The First-In, First-Out (FIFO) method is an inventory costing approach that assumes the first units of inventory purchased are the first ones sold. This means the costs of the oldest inventory items are expensed first when goods are sold. As a result, inventory remaining on the balance sheet is valued at the cost of the most recently acquired items. This method directly influences a company’s Cost of Goods Sold (COGS) and the reported value of its ending inventory. FIFO is recognized under Generally Accepted Accounting Principles (GAAP) in the U.S. and International Financial Reporting Standards (IFRS), making it a widely accepted accounting practice.

Common Users of FIFO

FIFO is a widely adopted inventory method, suited for industries where the physical flow of goods naturally follows a first-in, first-out pattern or where product obsolescence is a concern. Companies dealing with perishable goods, such as those in the food and beverage industry, frequently use FIFO to ensure older products are sold before they spoil. This approach helps minimize waste and maintain product freshness.

The pharmaceutical industry also relies on FIFO because many drugs have expiration dates and can lose effectiveness over time. By using FIFO, pharmaceutical companies ensure that medications with earlier expiration dates are distributed first, upholding product quality and safety. Similarly, fashion brands and electronics retailers often employ FIFO. In these sectors, products can quickly become outdated due to changing trends or rapid technological advancements, making it important to sell older stock promptly to avoid obsolescence. This method aligns accounting records with the physical reality of inventory management in businesses focused on high turnover or products with limited shelf lives.

FIFO’s Influence on Financial Statements

The choice of inventory method, including FIFO, directly impacts a company’s income statement and balance sheet. When costs are rising, a common scenario in inflationary environments, FIFO generally results in a lower Cost of Goods Sold (COGS) because it assumes older, less expensive inventory is sold first. This lower COGS leads to a higher reported gross profit and, consequently, a higher net income.

On the balance sheet, FIFO values ending inventory using the costs of the most recent purchases. In a period of rising costs, these newer items are usually more expensive, leading to a higher reported inventory asset value. Conversely, in a period of falling costs, FIFO results in a higher COGS and lower net income, while inventory is valued at lower, more recent costs. The method can lead to higher tax liabilities for companies during inflationary periods due to the increased net income.

Determining a Company’s Inventory Method

To determine a publicly traded company’s inventory costing method, examine its financial disclosures. This information is typically found within the footnotes to the financial statements, specifically in a section often titled “Summary of Significant Accounting Policies.” This section provides an overview of the accounting principles, methods, and practices the company has adopted.

For publicly traded companies, these financial statements are part of their annual report, known as a Form 10-K, filed with the Securities and Exchange Commission (SEC). Many companies provide an “Investor Relations” link on their corporate websites, which often includes direct access to their SEC filings. By navigating to the 10-K and locating the “Summary of Significant Accounting Policies” within the notes, one can identify the inventory valuation method, such as FIFO, LIFO, or weighted-average, that the company employs.