What is "First In First Out"?

Rule in which positions are closed in the order they were originally opened. Also known as FIFO.

Understanding FIFO

The FIFO method is used for cost flow assumption purposes. In manufacturing, as items progress to later development stages and as finished inventory items are sold, the associated costs with that product must be recognized as an expense. Under FIFO, it is assumed that the cost of inventory purchased first will be identified first. The dollar value of the total stock decreases in this process because the list has been removed from the company's ownership. The costs associated with the inventory may be calculated in several ways — one being the FIFO method.

Example About FIFO

Inventory is assigned costs as items are prepared for sale. This may occur through the purchase of the inventory or production costs, the purchase of materials, and labor utilization. These assigned costs are based on the order in which the product was used, and for FIFO, it is based on what arrived first. For example, if 100 items were purchased for $10 and 100 more items were purchased next for $15, FIFO would assign the cost of the first item resold of $10. After 100 items were sold, the new price of the article would become $15, regardless of any additional inventory purchases made.

The FIFO method follows the logic that a company would first sell the oldest inventory items and maintain the newest things in inventory to avoid obsolescence. Although the actual inventory valuation method used does not need to follow the basic flow of stock through a company, an entity must be able to support why it selected a particular inventory valuation method.