What Does the Acronym FIFO Stand For in Accounting?

The acronym FIFO stands for First-In, First-Out, a fundamental concept used across various disciplines, particularly within accounting and inventory management. This principle dictates a specific order of processing or valuation.

What First-In, First-Out Means

The FIFO principle assumes that the first items acquired or produced are the first ones sold, consumed, or disposed of. This means the oldest items in a stock or queue are processed before newer ones. It represents a cost flow assumption, dictating how costs are recognized rather than necessarily reflecting the physical movement of every item. While the physical flow of goods often aligns with FIFO, the core of the principle lies in its application for valuation purposes.

How FIFO Works

Imagine a queue at a customer service desk; the first person to arrive in line is the first person to be served. This logical sequence ensures that items are processed in the order of their entry.

This approach ensures that oldest items are moved out, preventing them from becoming stagnant. The method dictates a clear processing order, making the system predictable and orderly. Whether dealing with physical goods or abstract tasks, “first in, first out” provides a consistent framework for managing flow.

FIFO in Inventory Accounting

In inventory accounting, the FIFO principle is a widely accepted method for valuing inventory and calculating the Cost of Goods Sold (COGS). Under FIFO, the oldest inventory items are assumed to be sold first, and their associated costs are expensed on the income statement as goods are sold.

Conversely, the remaining inventory, known as ending inventory, is valued based on the cost of the most recently purchased items. This typically results in the ending inventory on the balance sheet reflecting more current market prices. For example, if a business buys 100 units at $5 each, then 100 more at $8 each, and sells 150 units, FIFO assumes the first 100 sold cost $5 each, and the next 50 cost $8 each, totaling $900 in COGS. This method is permitted under both U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).

During periods of rising costs, FIFO generally leads to a lower COGS because it uses the costs of older, cheaper inventory. This results in a higher reported net income, which can make a company appear more profitable to investors. However, this higher net income can also lead to a higher tax liability. Consistent application of FIFO helps financial statements reflect inventory costs and profitability.

Common Uses Beyond Inventory

Beyond its primary role in inventory accounting, the FIFO principle finds broad application in various other fields. In computer science, FIFO is fundamental to data structures like queues, where data elements are processed in the exact order they were received. This is similar to how a printer queue operates, handling print jobs in the sequence they were submitted.

Businesses dealing with perishable goods, such as food or pharmaceuticals, often physically manage their stock using a FIFO approach. This ensures that older products are sold or used before their expiration dates, minimizing waste and maintaining product quality. For instance, grocery stores arrange products so that customers naturally pick up items with earlier expiration dates first.

FIFO also applies to customer service queues, where individuals are typically served in the order of their arrival. This principle promotes fairness and manages expectations, as customers understand they will be attended to based on when they joined the line. This systematic approach helps streamline operations and enhances customer satisfaction across various service industries.