What Is the FIFO Method in Australian Accounting?

Inventory valuation helps businesses determine the worth of goods held for sale and their cost when sold. This accounting practice is essential for financial reporting, directly impacting a company’s financial statements. The First-In, First-Out (FIFO) method is a common approach for assigning costs to inventory, influencing reported financial performance.

The FIFO Concept

The First-In, First-Out (FIFO) method assumes that inventory acquired first is sold or consumed first. This principle assigns the cost of the oldest inventory to the cost of goods sold before newer inventory. Conceptually, imagine a bakery where fresh loaves of bread are continually added to the back of a shelf, and customers always pick loaves from the front. The bread that was placed on the shelf first is, therefore, the first to be sold.

This method aligns with the physical flow of goods for many businesses, particularly those dealing with perishable items or products with expiration dates, where selling older stock first is a practical necessity to minimize waste. Even for non-perishable goods, a FIFO approach often mirrors actual inventory management practices, as businesses typically aim to move older stock to prevent obsolescence or damage. The core idea is that the cost attached to the goods leaving inventory reflects the cost of the earliest purchases.

FIFO in Australian Inventory Valuation

In Australia, the First-In, First-Out (FIFO) method is a widely used approach for valuing inventory and calculating the cost of goods sold (COGS). Australian accounting standards permit the use of FIFO, along with the weighted-average cost method, for interchangeable inventory items. The Last-In, First-Out (LIFO) method is not permitted under Australian Accounting Standards (AASB), which are based on International Financial Reporting Standards (IFRS).

To illustrate, if a business buys 10 units at $10 each, then 15 units at $12 each, and sells 20 units: The first 10 units sold are costed at $10 each (total $100), and the remaining 10 units sold are costed from the next batch at $12 each (total $120). The total cost of goods sold is $220. The remaining 5 units in inventory are valued at $12 each, representing the cost of the most recently purchased items.

Financial Reporting Implications

Applying the FIFO method influences a company’s financial statements, affecting both the income statement and the balance sheet. During periods of rising costs (inflation), FIFO generally results in a lower reported cost of goods sold. This occurs because older, less expensive inventory costs are expensed first. A lower cost of goods sold leads to a higher reported gross profit and net income for the period.

Conversely, the ending inventory balance on the balance sheet under FIFO tends to be higher during inflation, as remaining inventory consists of more recently purchased, higher-cost items. If costs are falling, or in a deflationary period, the effects of FIFO are reversed: a higher cost of goods sold, lower gross profit and net income, and a lower ending inventory value.

Australian Accounting Standards for Inventory

Australian Accounting Standard Board (AASB) 102, “Inventories,” governs the accounting treatment for inventories in Australia. This standard guides how inventories are recognized, measured, and disclosed in financial statements. Adherence to AASB 102 ensures consistency and comparability in financial reporting.

AASB 102 mandates that inventories be measured at the lower of cost and net realisable value. Net realisable value is the estimated selling price, less estimated costs of completion and sale. The standard also specifies disclosure requirements, including accounting policies, total carrying amount, and any inventory write-downs recognized as an expense.