First In First Out (FIFO) – Materials and Inventory Costing Method:
- Define and explain FIFO method.
- Give an example of FIFO costing method
- What are advantages and disadvantages of fist in first out (FIFO) costing method?
- Definition and Explanation of FIFO Method
- Advantages of First in First out-FIFO-Costing Method
- Example of FIFO Method
- Disadvantages or Limitations of FIFO Costing Method
Definition and Explanation:
The first in first out (FIFO) method of costing is used to introduce the subject of materials costing. The FIFO method of costing issued materials follows the principle that materials used should carry the actual experienced cost of the specific units used. The methods assumes that materials are issued from the oldest supply in stock and that the cost of those units when placed in stock is the cost of those same units when issued. However, FIFO costing may be used even though physical withdrawal is in a different order.
Advantages of First in First out (FIFO) Costing Method:
Advantages claimed for first in first (FIFO) out costing method are:
- Materials used are drawn from the cost record in a logical and systematic manner.
- Movement of materials in a continuous, orderly, single file manner represents a condition necessary to and consistent with efficient materials control, particularly for materials subject to deterioration, decay and quality are style changes.
FIFO method is recommended whenever:
- The size and cost of units are large.
- Materials are easily identified as belonging to a particular purchased lot.
- Not more than two or three different receipts of the materials are on a materials card at one time.
This example is based on the following transactions:
(1)Beginning balance: 800 units @ $6 per unit.
(4)Received 200 units @ $7 per unit.
(10)Received 200 units @ $8 per unit.
(11)Issued 800 units.
(12)Received 400 units @ $8 per unit.
(20)Issued 500 units.
(25)Returned 100 excess units from the factory to the storeroom to be recorded at the latest issued price.
(28)Received 600 units @ $9 per unit.
Calculation for the above transactions would be as follows:
FIFO Costing Method
01. Beginning balance
800 units @ $6
|| 200 units @ $7
|| 200 units @ $8
| 11. Issued
||800 units @ $6
| 200 units @ $7
|| 200 units @ $8
|| 400 units @ $8
| 20. Issued
||200 units @ $7
||300 units @ $8
| 300 units @ $8
|25. Returned to storeroom
|| 100 units @ $8
|| 600 units @ $9
| 400 units @ $8
|| 600 units @ $9
Disadvantages or Limitations of FIFO Method
FIFO method is definitely awkward if frequent purchases are made at different prices and if units from several purchases are on hand at the same time. Added costing difficulties arise when returns to vendors or to the storeroom occur.
You may also be interested in other useful articles from “controlling and costing materials” chapter:
- Purchases of productive material
- Purchases of supplies, services, and repairs
- Materials purchasing forms
- Receiving materials
- Invoice approval and data processing
- Correcting invoices
- Electronic data processing (EDP) for materials received and issued
- Cost of acquiring materials
- Storage and use of materials
- Issuing and costing materials into production
- Materials ledger card – perpetual inventory
- First-in-First-Out (FIFO) Costing Method
- Average Costing Method
- Last-in-First-Out (LIFO) Costing Method
- Other Methods-Month end average cost, last purchase price or market price at date of issue, and standard cost
- Inventory valuation at cost or market whichever is lower
- American Institute of Certified Public Accountant (AICPA) cost or market rules
- Adjustments for departures from the costing method used
- Inventory pricing and interim financial reporting
- Transfer of materials cost to finished production
- Physical inventory
- Adjusting Materials Ledger Cards and Accounts to Conform to Inventory Accounts
- Scrap and waste
- Spoiled goods
- Defective work
- Discussion Questions and Answers about Controlling and Costing Materials