FIFO

FIFO Definition

FIFO stands for First In, First Out—an inventory costing method where the oldest items purchased are assumed to be sold first. When you calculate cost of goods sold (COGS), FIFO uses the cost of your earliest inventory purchases before moving to newer ones. It's one of the most common inventory valuation methods for small businesses.

FIFO in Practice — Example

A candle maker buys 100 jars of wax in January at $5 each and another 100 in February at $6 each. In March, she sells 120 candles. Under FIFO, the first 100 sold are costed at $5 (January batch), and the remaining 20 are costed at $6 (February batch). Her COGS for those 120 candles is $620. The 80 jars remaining in inventory are valued at $6 each, or $480.

Why FIFO Matters for Your Books

FIFO generally produces a higher ending inventory value and lower COGS during periods of rising prices, which means higher reported profits. This makes FIFO attractive for businesses seeking loan approval or investor confidence, since the balance sheet looks stronger.

For most small businesses, FIFO also matches how inventory actually moves. A bakery sells the oldest bread first. A retailer rotates stock so older items sell before newer ones. Using FIFO aligns your accounting with physical reality, which makes your books easier to understand and audit.

FIFO is also the method required under IFRS (International Financial Reporting Standards), and it's accepted under GAAP. If you're ever unsure which method to use, FIFO is the safe, widely accepted default for most small businesses.

How FIFO Shows Up in QuickBooks

QBO uses FIFO as its default inventory costing method—you don't need to configure anything special. When you enable inventory tracking (gear icon → Account and Settings → Sales → Track inventory), QBO automatically applies FIFO to calculate COGS. You can see inventory values on the Balance Sheet under Current Assets and COGS on the Profit & Loss. Run the Inventory Valuation Summary report for a breakdown by product.

Common Mistakes

Mixing FIFO and LIFO within the same entity: Pick one method and apply it consistently. Switching methods mid-year creates audit issues and requires IRS approval.

Not tracking inventory purchase dates: FIFO only works when you know which items were purchased first. Sloppy purchase records make FIFO calculations unreliable.

Assuming FIFO means physical rotation: FIFO is an accounting assumption, not a warehousing requirement. Your physical inventory flow may differ from your cost flow.

FAQ

Q: Is FIFO better than LIFO?

A: It depends on your goals. FIFO shows higher profits when prices rise, which is better for lending and investors. LIFO shows lower profits and can reduce your tax bill. Most small businesses use FIFO because it's simpler and matches QBO's default.

Q: Can I switch from LIFO to FIFO?

A: Yes, but switching inventory methods requires IRS approval (Form 3115). Talk to your accountant before making the change.

Related Terms

LIFO

Cost of Goods Sold

Inventory

Inventory Turnover

Lower of Cost or Market

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