FIFO (First-In, First-Out)
What Is FIFO?
FIFO (First-In, First-Out) is an asset management and valuation method in which assets produced or acquired first are sold, used, or disposed of first.
FIFO stands for "First-In, First-Out." It is a method used for cost flow assumption purposes in the cost of goods sold (COGS) calculation. The FIFO method assumes that the oldest products in a company's inventory have been sold first. The costs paid for those oldest products are the ones used in the calculation. Conceptually, this makes sense for most businesses. A grocery store, for example, always tries to sell the oldest milk or produce first to prevent spoilage. In accounting, adhering to this flow means that the ending inventory on the balance sheet consists of the most recently purchased (and likely most expensive, due to inflation) goods.
Key Takeaways
- FIFO assumes the oldest inventory items are sold first.
- In rising markets, FIFO results in lower Cost of Goods Sold (COGS) and higher net income.
- It is the standard method for stock sales in many tax jurisdictions (unless specified otherwise).
- It generally mimics the actual physical flow of goods (e.g., selling the oldest milk first).
- The opposite method is LIFO (Last-In, First-Out).
FIFO in Stock Trading and Taxes
For investors, FIFO is critical for calculating capital gains taxes. When you sell shares of a stock, the IRS (and most tax authorities) defaults to the FIFO method unless you specify otherwise (like "Specific Identification"). This means if you bought 100 shares of Apple at $50 years ago, and 100 shares at $150 yesterday, and you sell 100 shares today at $160, FIFO assumes you sold the $50 shares. This results in a larger capital gain ($110 per share profit) and a potentially higher tax bill, though it might be taxed at the lower long-term capital gains rate.
Real-World Example: Inventory Accounting
A widget company buys inventory over three months.
FIFO vs. LIFO
How accounting choices change profit numbers.
| Feature | FIFO (First-In, First-Out) | LIFO (Last-In, First-Out) |
|---|---|---|
| Flow Assumption | Oldest sold first | Newest sold first |
| In Inflationary Environment | Higher Profit, Higher Taxes | Lower Profit, Lower Taxes |
| Inventory Value | Reflects current market prices | Reflects old/outdated prices |
| International Standards | Allowed under IFRS | Banned under IFRS (US GAAP only) |
FAQs
It depends on the goal. FIFO shows a stronger balance sheet (inventory is valued at current prices) and higher net income, which investors like. LIFO reduces taxable income during inflation, which saves cash, but makes the balance sheet look outdated.
Yes. Most brokerages allow you to select "Specific Lot Identification" or "LIFO" at the time of the trade. This allows you to sell the shares with the highest cost basis first (minimizing gains) or the ones held longest (for long-term tax rates).
It is the simplest method to track and audit. It provides a consistent standard for calculating gains and losses across all taxpayers.
The Bottom Line
FIFO is the most logical and widely used method for valuing inventory and calculating investment gains. By matching the physical flow of goods (selling the old stuff first), it provides an accurate picture of the current value of remaining assets. However, in periods of high inflation, it can lead to higher tax bills compared to LIFO. Understanding FIFO is essential for analyzing company financial statements and managing your own tax liability when trading stocks.
Related Terms
More in Accounting
At a Glance
Key Takeaways
- FIFO assumes the oldest inventory items are sold first.
- In rising markets, FIFO results in lower Cost of Goods Sold (COGS) and higher net income.
- It is the standard method for stock sales in many tax jurisdictions (unless specified otherwise).
- It generally mimics the actual physical flow of goods (e.g., selling the oldest milk first).