Basically, FIFO uses the price of the FIRST batch purchased for all issues until stock of that batch is exhausted. Then the price of the next batch received is used and so on.
Illustration:
Assuming there is no opening stock and the following reflects the stock movement:
Mar 2 Receipt 100 units @ $1.00 = $100.00
Mar 3 Receipt 150 units @$1.20 = $180.00
Mar 20 Receipt 200 units @$1.50 = $300.00
Mar 29 Issues 400 units
Using the FIFO method:
(a) the cost assigned to the 300 units will be:
100 units @$1.00=$100.00
150 units @$1.20=$180.00
150 units @$1.50=$225.00
400 units = $508.00
(b) the closing stock of 50 units( total receipt(450) minus total issue(400)) will be valued at the LATEST price which is : 50 units @$1.50 =$75.00
The following are the advantages and disadvantage of FIFO method:
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Advantages: |
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It is realistic as this method assume the earliest batch of receipt are issued first and follow next the later on; What’s left is the current balance of stock which reflects a fairer representation of stock valuation. Hence, the closing stock stated in the Balance Sheet should be reasonably close to its market value at the Balance Sheet date. |
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Disadvantages: |
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Using this FIFO method, it provides the LOWEST cost of goods sold during period of rising prices and the HIGHEST cost of goods sold during period of declining prices hence it shows a big fluctuations in profitability in period where prices are not stable; |
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This method is cumbersome as we need to follow the above said method of exhausting the first batch and so on |