FIFO stands for first-in, first-out. It has a couple of uses:
- One method to determine the cost basis of the mutual fund or stock shares you sell.
- An accounting method by corporations for inventory tracking and cost of goods sold (COGS) calculation.
Under FIFO, the first shares purchased are considered the first shares sold. This is the IRS's default method. That is, unless you direct your broker to sell certain shares, the IRS assumes that the first shares purchased are the ones sold if you sell only a portion of your holding. Of course, those shares tend to be the lowest-priced shares, so this method usually results in a higher gain. A higher gain means higher taxes. Yay, IRS.
Inventory and COGS
FIFO is one of the two primary ways of tracking inventory on the balance sheet. (The other is the LIFO method, and some companies use the average cost method.) The first inventory purchased is considered the the first sold, regardless if the items sold were physically the first ones purchased or not. In other words, this is an accounting method, not a physical tracking method. So, it doesn't necessarily reflect reality.
FIFO paints a more up-to-date picture of inventory costs. Most foreign companies use FIFO, while most U.S. companies use a different method called LIFO (last-in, first-out). It is considered the more conservative method and usually results in higher taxes than LIFO.
A corporation that uses FIFO must use it consistently (i.e. it can't use FIFO on it's annual statements but tell the taxman the LIFO number).
An example of how it works
Suppose XYZ company sells Gizmos. It tracks actual inventory as follows, during one quarter:
|Day 0||Beginning balance||1,000||$10,000|
| First 1000 are from beginning balance and had cost of $10,000.|
Next 200 are from those purchased on day 10 and had cost of $2,200.
|From those purchased on day 10 and had a cost of $2,200|
|Day 90||Ending balance||1300||$13,400|
Under FIFO, you can see that the ones "sold" start at the earliest and work their way forward.
The COGS for this quarter can be calculated two ways.
First, take the sum of the costs of the "sold" items from the above tracking table: $10,000 + $2,200 + $2,200 = $14,400. Unless, however, you have access to a table like the above (which you won't), you can't do it this way.
Second, take the total amount spent on new purchases, add beginning inventory, and subtract ending inventory: ($5,500 + $8,400 + $3,900) + $10,000 - $13,400 = $14,400. The individual items purchased won't be available, but the total amount is available from the operating section of the company's statement of cash flow. The beginning and ending inventory balances are available on the balance sheets.
Retailers, especially those who sell perishable goods such as grocers, try to make FIFO a reality as much as possible through the practice of facing. Facing is merely the practice of placing oldest items to the front of shelves (or closest to the customer) and newer items to the back. The object is to get consumers to pick up the oldest items first.