Definition of First in First out (FIFO) Method of Costing
First in First out (FIFO) is an inventory costing method that assumes that the costs attached to the first goods purchased are the costs of the first goods sold.
The principle as to flow of cost followed by first in first out (FIFO) method of costing is clearly depicted by its title. The method assumes, the first cost received in stores is the first cost that goes out from the stores. In other words, cost of materials is charged to production in the order of purchases. The earlier costs recorded in materials ledger cards are used for costing requisitions and the balance is composed of units received later.
Explanation of the FIFO Method of Costing
The first in first out method of costing (FIFO) is based upon the assumption that the various lots of materials purchased are used in the same order in which they are received i.e. the materials are issued from the oldest supply in stock in this method of costing. The materials used in a job or process are charged at the price of their original purchase. That is why this method is sometimes called “Original Price Method“.
The return from the factory to the store-room of excess materials issued for a particular job be treated as the oldest stock on hand and be placed in the materials card balance ahead of all the units in hand at the same price as it was issued to the factory.
Advantages of FIFO Method of Costing
The following are the main advantages of FIFO method of costing.
- The FIFO method of costing is simple to operate because no complicated calculation is involved.
- Materials used are drawn from the cost-record in a legal order.
- Materials issued are charged to production at actual cost in order of their receipts,
- The valuation of closing inventory represents nearer to current market price.
- The FIFO method is beneficial whenever the size and cost of material units are large.
Disadvantages of FIFO Method of Costing
The following are the disadvantages and drawbacks of FIFO method of costing.
- The cost of material charged to production may not reflect the current market price.
- The record-keeping may become difficult whose number of purchases made of the same material at different prices.
- Under FIFO method costing difficulties arise when returning to vendors.
- When excess material is returned from factory to storeroom, the problem of costing arises.
Using (FIFO) method shows the value of the stock on hand.
- April 01: Inventories on hand: 50 units at the rate of $2 and 100 units at the rate of $4.50
- April 05: Purchased 100 units at a rate of $1.80
- April 06: 10 units of the inventories purchased on 5th April at the rate of $1.80 are returned to the supplier
- April 10: 80 units were issued to factory
- April 15: 50 units were issued to factory
- April 20: 20 units were purchased at the rate of $1.50
- April 25: 70 units were issued to factory
- April 30: 50 units purchased at $1.70
- April 30: Out of units issued to the factory on 25th April, 10 units were returned to the store