First in, First out (FIFO) is an inventory valuation method used to determine the cost of goods sold (COGS) and the value of ending inventory. Under the FIFO method, the first items purchased or produced are assumed to be the first ones sold or used, hence the name “first in, first out.”

Key principles of the FIFO method include:

Sequential Sale or Usage: FIFO assumes that inventory items are sold or used in the order they are acquired or produced. Therefore, the cost of the oldest inventory (earliest purchases) is matched with revenue first, followed by the cost of the newer inventory.

Cost of Goods Sold (COGS): The cost of goods sold under the FIFO method is calculated by multiplying the quantity of goods sold during a specific period by the unit cost of the oldest inventory on hand at the time of sale.

Ending Inventory Valuation: The value of the ending inventory is based on the cost of the most recent inventory purchases, as the older inventory is assumed to have been sold first. The ending inventory is valued at the cost of the remaining units on hand at the end of the accounting period.

Income Statement Impact: Using the FIFO method typically results in a higher reported net income during periods of rising prices because the cost of goods sold is based on older, lower-cost inventory, leaving newer, higher-cost inventory in ending inventory. This leads to lower COGS and higher gross profit, resulting in higher net income.