At the end of each financial year, an inventory valuation is carried out in which the stock is valued and recorded. There are different techniques for carrying out such a valuation, and the most common in Sweden is called FIFO. Here PostNord tells you what you need to know about the FIFO method and shows examples of how it is used.
What is FIFO?
FIFO is an abbreviation for First-In-First-Out, and is a method used when inventories are to be valued. FIFO means that the product purchased first is also sold first, which is necessary to know in the context of inventory valuation if you have purchased the same goods at different prices.
Why use FIFO?
The main purpose of using FIFO is to get the right basis for the company's financial statements. According to the Swedish Tax Agency's rules, stocks must be inventoried using the FIFO method, so choosing a different method would make the accounting for warehousing much more complicated than it needs to be. Another reason for using the FIFO method is that the goods are used in the right order, which is particularly important in cases where the goods have an expiry date. In addition, it will be much easier to trace the goods if quality problems are detected and the goods need to be recalled.
How to use the FIFO method?
A skin care retailer must value its stock at the end of the financial year. During the year, skin creams were purchased on five separate occasions. Changes in currency caused the purchase price to vary as shown in the table below.
|Month||Product||Number||Unit price (SEK)|
At the time of the inventory, the retailer had a total of 438 cans in stock. The FIFO method is used for inventory valuation, which means that the most recently purchased products remain in stock. As the retailer had 438 cans left, this means that the purchases from November (100 cans) and September (250 cans) and 88 cans from April are still in stock.
The value of the stock is calculated as follows:
100×54 + 250×52 + 88×51 = 5 400 + 13 000 + 4488 = 22 888 SEK
Advantages and disadvantages of FIFO
Advantages of the FIFO method:
- The method is easy to understand and use.
- The method reduces operational waste because products are more likely to be sold before the expiry date.
- Products in stock better reflect market value.
- This method makes it more difficult to manipulate the accounts.
Disadvantages of the FIFO method:
- If purchase prices rise sharply and the company raises its selling prices at the same time, the method may give a false picture because the profit on the most recently sold goods is based on the lower purchase price. This lag effect means that the profit looks higher than it is.
- The method may result in companies having to pay higher taxes as the gap between expenditure and profits widens.
What is the difference between FIFO and LIFO?
FIFO and LIFO are both valuation methods, but LIFO stands for Last-In-First-Out, which means that the method works exactly the opposite way to FIFO. According to the LIFO method, it is therefore the most recently purchased goods that should be sold first. This assumes that the products do not age or deteriorate due to prolonged storage.
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