Defined

• FIFO requires a company to transfer the cost for inventory purchased first to the cost of goods sold account. A company must track each inventory purchase and separate the cost for the items using this method properly. For example, a company purchases 100 widgets over three months. The first 50 cost $2.50, the next 25 cost $2.75 and the last 25 cost $3.25. The company must list these based on the cost paid to acquire the items. The first ones sold will cost $2.50 a piece.
  
  

Income Statement Effects

• The cost of goods sold account holds information detailing the cost for inventory items sold. FIFO generally results in a lower cost of goods sold number on the income statement. This increases gross profit and net operating profit as well. The reason behind this comes from inflation that often raises the cost of goods a company sells to consumers. This effect will usually occur as long as the company uses FIFO.
  
  

Balance Sheet Effects

• A company's balance sheet also has FIFO affects. Ending inventory reported on the balance sheet will usually be higher under FIFO. This increases a company's net wealth and working capital, which are total assets less total liabilities and current assets less current liabilities, respectively. Higher asset dollar amounts usually make a company look financially stronger as the assets offset liabilities on the balance sheet.
  
  

Considerations

• An alternate valuation method for FIFO is the last in, first out valuation method. LIFO is essentially the opposite of FIFO. Goods purchased last must go into the cost of goods sold first. This increases the cost of goods sold account, lowers gross profit and net operating profit and results in lower ending inventory on the balance sheet.