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AAT Accountancy: When is FIFO used in accountancy?

CMS Vocational Training Hadyn Luke posted this on Wednesday 19th of October 2016 Hadyn Luke 19/10/2016

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AAT Accountancy: When is FIFO used in accountancy?

When is FIFO used in accountancy?

FIFO stands for First In First Out and relates to inventory (stock).

Students studying for AAT (Association of Accounting Technicians) Level 2 Certificate in Accounting on Basic Costing are required to have an understanding of how cost accounting systems work within an organisation.

This includes comprehension of the nature of inventory at its different stages within the production process.

This blog has been written to support those learners enrolled on classroom and distance learning based AAT courses, as well as those interested in learning more about accountancy technician practises or wanting to become qualified as a AAT Accountancy Technician in the Huddersfield, Wakefield and Leeds region.

AAT accountancy courses available include:

What other methods of inventory are there?

Other inventory options include:

LIFO – Last In First Out

AVCO – Weighted Average

What is the purpose of FIFO?

In accountancy FIFO can be used to reflect the movement of any product in and out of inventory.

However, it is particularly used with perishable goods. This is because First In First Out means that the oldest goods will leave the stores first.

How does FIFO affect inventory?

First, it affects the value of the inventory. If issues are made from the oldest inventory available, transfers to store will be made at the oldest prices. When the inventory is valued, it will be based on the latest purchases at the newest prices.

Second, as outlined above, it means that in the case of perishable goods, the older products will leave inventory first to prevent them remaining at the back of the store, where they might go past their sell by date.

What are the features of FIFO?

First, it is one of the easier accountancy systems to understand. However, it is worth noting that following the FIFO accountancy system can result in two jobs that are started on the same day showing a different cost for the same amount of the same material.

In times of rapidly increasing prices, there are two outcomes of using FIFO:

a)      material issued at an early, potentially unrealistically low price will result in the job showing an unusually large profit;

b)      overall, FIFO will give a higher profit figure than LIFO or AVCO.

An example of FIFO accountancy system in action

A business uses FIFO for the movement of goods in and out of its store.

On 1 May, 200kg of goods are moved into its store (receipts), priced at £9:

200 x £9 = £1,800

On 2 May, 100kg of goods are moved into its store, priced at £10.80:

100 x £10.80 = £1,080

The closing inventory value at the end of 2 May would be:

£1,800 + £1,080 = £2,880

If 50kg of goods are issued from the store on 3 May, under FIFO the value would be calculated from the price of the earliest goods moved into the store, which in this case would be the goods moved in on 1 May at £9 per kilo:

50g x £9 = £450

So the closing inventory on 3 May would be calculated using the closing inventory value at the end of 2 May (£2,880), minus the cost of the goods moved out on 3 May (£450):

£2,880 – £450 = £2,430

Note that the closing inventory value would be a different figure if the organisation was using either LIFO or AVCO to calculate the result.

Conclusion

FIFO is a commonly used method of calculating inventory valuations and issues of inventories. It’s essential for AAT accountancy students to understand FIFO alongside the other methods of managing inventories and to be able to make calculations based on these systems.