Businesses that maintain inventory choose from several methods of valuing the inventory. These methods include weighted average, LIFO or FIFO. The weighted average method calculates an average unit cost for each item. LIFO, or last-in first-out, assumes that the company ships the last inventory items received first. Many companies choose FIFO, or first-in first-out, which assumes that the company ships the first inventory items received first.
The FIFO method of inventory valuation calculates an inventory value by identifying when the company purchased each unit of inventory and using the most recent purchases to value the inventory. The company considers the earlier purchases and the beginning inventory to be sold first. Companies who rotate inventory to sell the oldest units first often use FIFO to value their inventory.
The first step to calculate a FIFO inventory value requires the accountant to determine the ending inventory quantity. The accountant relies on the accounting system to provide this quantity. Periodically, the accountant verifies the inventory quantity by collaborating with the warehouse employees to physically count the inventory items. The physical inventory count represents the accurate ending inventory quantity, and the accountant adjusts the quantity recorded in the system to reflect this amount.
The second step to calculate a FIFO inventory value involves analyzing each individual purchase, both the quantity and unit cost, that occurred during the period. The accountant starts by listing the total ending inventory quantity and realizing that she needs to determine the value of each unit. She compares the latest purchase quantity to the ending inventory quantity. If the ending inventory quantity exceeds the latest purchase quantity, she records the quantity and the unit cost from that purchase and reduces the units to account for by this amount. She proceeds to the next latest purchase and compares that quantity to the remaining number of units. The process continues until she reaches a point where the purchase quantity exceeds the number of units to account for. At this point, she records the remaining quantity along with the unit cost from that purchase.
Total FIFO Inventory
To calculate the total FIFO inventory value, the accountant multiplies each quantity by the corresponding unit cost. After extending each quantity, he adds the totals together. This amount represents the ending FIFO inventory value.