The First In First Out (FIFO)
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As we have seen under the last in first out (LIFO) cost flow assumption, identifying each and every item in inventory is neither practical nor not cost-effective for large volumes of inventory. Specific Identification is better suited for low turnover, high value items that are more easily tracked, such as vehicles, heavy machinery, high priced jewelry, or custom homes.
For most businesses, thousands and even millions of items held in inventory require a more cost-effective and practical way to measure cost of goods sold and inventory. The four main cost flow methods are FIFO, LIFO, Average Cost, and Specific Identification.
These cost flow assumptions simplify cost of goods sold and inventory accounting by reducing information required to a few data points in the cost flow process, as opposed to tracking the fluctuating cost of every inventory item that are quickly buried and obscured in the cost flow process.
Specific Identification Illustrated
For example, the actual physical flow of inventory items which Sunny purchased over the past three months are as follows:
Actual Physical Flow of Inventory
| Sunglasses Purchased two months ago: | Sunglasses Purchased one month ago: | Sunglasses purchased this week: |
| 240 Sunglasses @$14 each: | 240 Sunglasses @$15 each: | 240 Sunglasses @$16 each: |
When Sunny sells twenty five pairs of sunglasses one sunny afternoon, it is unlikely he knows which original order the pair of sunglasses came from. Unbeknownst to Sunny, the first twelve sunglasses came from Box 1 at $14 each, the next ten sold came from Box #2 at $15 each, and the last three pairs came from Box #3 at $16 each. If Sunny tracked every pair of sunglasses coming in, he would total his cost of goods sold based on specifically identifying the cost of each inventory item:
Inventory Accounting and COGS Using Specific Identification
| Sunglasses Purchased two months ago: | Sunglasses Purchased one month ago: | Sunglasses purchased this week: |
| Sunglasses Purchased two months ago: | Sunglasses Purchased one month ago: | Sunglasses purchased this week: |
First In First Out Illustrated
Alternatively, Sunny can calculate cost of goods sold and Ending Inventory based on the cost flow assumption that the first inventory items ordered are the first items sold. He would not need to know the price of each item, but only the amount of inventory in each purchase, including beginning inventory.
Since the first items ordered two months ago cost $14 a pair, and the amount sold was 25 pairs of sunglasses, all of the pairs sold are applied to cost of goods sold at $14 per pair, the cost from the first box ordered, assuming no beginning inventory:
| Sunglasses Purchased two months ago: | Sunglasses Purchased one month ago: | Sunglasses purchased this week: |
Similarly, ending inventory is based on the cost flow assumption that the first items in were sold, and the last items in are still here (LISH):
| Sunglasses Purchased two months ago: | Sunglasses Purchased one month ago: | Sunglasses purchased this week: |
Note that the specific identification method, LIFO, and FIFO all result in total goods of $10,800, but FIFO assigns less to cost of goods sold and more to ending inventory during periods of rising prices, while LIFO assigns more to cost of goods sold and less to Ending Inventory during the same period.
Strengths and Weaknesses of the First in First Out Method
First in First Out Strengths:
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