FIFO

							Stock Valuation: First In First Out (FIFO)
So far we have assumed that the cost of stock is constant, that is, it does not change over time:

Q 5

STOCK CARD: Chairs IN OUT BALANCE C V Q C V Q C V 3 200 600 200 1000 8 200 1600 2 200 400 6 200 1200

However, constant prices is not realistic!

Example: Chairs.

Q
1/1 BAL 5 2 3/1 CHQ 4/1 CHQ 5/1 REC

STOCK CARD: Chairs IN OUT BALANCE C V Q C V Q C V
220 230 1100 460 3 3 5 3 5 2 200 200 220 200 220 230 600 600 1100 600 1100 460

What happens when the business sells stock on 5/1?

EG: What happens if 4 chairs are sold on 5/1?

Identified Cost.
When the chairs are purchased, they are tagged or coded in some way to identify their cost price: this would be easy for chairs. Assume the tags or codes identify that the 4 sales were: 1 chair @ $200, 2 chairs @ $220, 1 chair @ $230

STOCK CARD: Chairs IN OUT BALANCE Q C V Q C V Q C V
1/1 BAL 3/1 CHQ 4/1 CHQ 5 2 220 230 1100 460 1 2 1 200 220 230 200 440 230 3 3 5 3 5 2 2 3 1 200 200 220 200 220 230 200 220 230 600 600 1100 600 1100 460 400 660 230

5/1 REC

For stock that is easy to tag or code, such as Chairs, identified cost can be used to assign cost to the stock. What about stock that is not easy to tag or code?
Example:

Bulk grain trader

Purchases of grain (IN)

Sales of grain (OUT)

Because of the nature of the stock, separate purchases cannot be tagged or coded: the stock merges together and loses its individual identity. So how is the stock valued?

First In First Out (FIFO)
FIFO assumes stock is sold on a FIFO basis, that is, the oldest stock is sold first. This method can be used by businesses which cannot tag or code their stock or, if they can, they prefer FIFO because it is administratively easier and cheaper to operate than identified cost. FIFO = last in last out!

Bulk Grain example:
1/1 Balance at start: 90 tonnes @ $100 tonne 3/1 Purchase: 80 tonnes @ $110 tonne 5/1 Sales: 120 tonnes.

STOCK CARD: Bulk Grain FIFO IN OUT BALANCE Q C V Q C V Q C V
1/1 BAL 3/1 CHQ 80 5/1 REC 110 8800 90 30 100 110 9000 3300 90 90 80 50 100 100 110 110 9000 9000 8800 5500

Chair example using FIFO
Even though the chair business could use identified cost, it may use FIFO since it would not need to tag or code its stock. FIFO is administratively easier and cheaper to operate than identified cost.

Sold 4 chairs on 5/1. Using FIFO.

STOCK CARD: Chairs: FIFO

Q
1/1 BAL 3/1 CHQ 5

IN C
220

V
1100

OUT Q C V

BALANCE Q C V
3 3 5 3 5 2 200 200 220 200 220 230 220 230 600 600 1100 600 1100 460 880 460

4/1 CHQ

2

230

460 3 1 200 220 600 220

5/1 REC

4 2

Sold 4 units. Using FIFO, oldest stock is sold first, thus 3 @ $200 then 1 @ $220.

Other theory!
Identified cost is a 100% accurate method of stock valuation which means: Profit/Loss statement: Cost of sales, gross and net profit are accurate Balance Sheet: Value of stock and owner’s equity (due to profit impact) are accurate Thus identified cost = reliability characteristic of the reports.

More theory!
FIFO is based on an assumption that stock flows in a first in first out basis: this may not match the actual stock flows thus FIFO is unlikely to be a 100% accurate method of stock valuation: Profit/Loss statement: Cost of sales, gross and net profits would reflect this possible inaccuracy (less reliable) Balance Sheet: Value of stock and owner’s equity (due to profit impact) would reflect this possible inaccuracy

Thus FIFO reduces the reliability characteristic of the reports.

… and more theory!
Units 3&4 only require a knowledge of FIFO not identified cost (but good to know for comparison purposes)

Identified cost may not be possible/realistic for some businesses due to their type of stock (grain, fuel, hard to tag/code stock etc) so FIFO is used.
FIFO is often a realistic assumption is many businesses (think, eg, perishable stock) FIFO is also used by many businesses which could use identified cost but choose FIFO since it is easier and cheaper to administer

… and even more theory!
•Usually, overtime, prices tend to rise. •This means that using FIFO stock at end is valued at higher more recent prices (does this contravene conservatism?) and cost of sales is valued at earlier or cheaper prices. Gross and net profit thus tend to be higher using FIFO.