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What is the First-in, First-out Method?The first in, first out (FIFO) method of inventory valuation is a cost flow assumption that the first goods purchased are also the first goods sold. In most companies, this assumption closely matches the actual flow of goods, and so is considered the most theoretically correct inventory valuation method. The FIFO flow concept is a logical one for a business to follow, since selling off the oldest goods first reduces the risk of inventory obsolescence. Understanding the First-in, First-out MethodUnder the FIFO method, the earliest goods purchased are the first ones removed from the inventory account. This results in the remaining items in inventory being accounted for at the most recently incurred costs, so that the inventory asset recorded on the balance sheet contains costs quite close to the most recent costs that could be obtained in the marketplace. Conversely, this method also results in older historical costs being matched against current revenues and recorded in the cost of goods sold; this means that the gross margin does not necessarily reflect a proper matching of revenues and costs. For example, in an inflationary environment, current-cost revenue dollars will be matched against older and lower-cost inventory items, which yields the highest possible gross margin. The FIFO method is allowed under both Generally Accepted Accounting Principles and International Financial Reporting Standards. The FIFO method provides the same results under either the periodic or perpetual inventory system. Example of the First-in, First-out MethodMilagro Corporation decides to use the FIFO method for the month of January. During that month, it records the following transactions: The cost of goods sold in units is calculated as: 100 Beginning inventory + 200 Purchased – 125 Ending inventory = 175 Units Milagro’s controller uses the information in the preceding table to calculate the cost of goods sold for January, as well as the cost of the inventory balance as of the end of January. Thus, the first FIFO layer, which was the beginning inventory layer, is completely used up during the month, as well as half of Layer 2, leaving half of Layer 2 and all of Layer 3 to be the sole components of the ending inventory. Note that the $42,000 cost of goods sold and $36,000 ending inventory equals the $78,000 combined total of beginning inventory and purchases during the month. The Difference Between FIFO and LIFOThe reverse approach to inventory valuation is the LIFO method, where the items most recently added to inventory are assumed to have been used first. This approach is useful in an inflationary environment, where the most recently-purchased higher-cost items are removed from the cost layering first, while older, lower-cost items are retained in inventory. This means that the ending inventory balance tends to be lower, while the cost of goods sold is increased, resulting in lower taxable profits. The use of LIFO is banned under IFRS.  CHAPTER 6 INVENTORIES SUMMARY OF QUESTIONS BY STUDY OBJECTIVES AND BLOOM’S TAXONOMY Item SO BT Item SO BT Item SO BT Item SO BT Item SO BT True-False Statements 1. 1 C 8. 2 C15.3K a22.7C sg29. 3C 2. 1 C 9. 2 C 16.3 C a23.7 K sg30. 4 K 3. 1 K 10. 2 C 17.4 K a24.8 K sg31. 5 K 4. 1 K 11. 2 K 18.4 K a25.8 K sg,a32. 7 K 5. 1 K 12. 3 K 19.5 C sg26.1 C sg,a33. 8 K 6. 2 K 13. 3 K 20.5 K sg27.2 K 7. 2 K 14. 3 K 21.6 C sg28.2 K Multiple Choice Questions 34. 1 K 58. 2 C82. 3 P106.3K a130. 7 P 35. 1 K 59. 2 K 83.3 AP 107.3 C a131. 7 C 36. 1 K 60. 2 K 84.2 AP 108.3 AP a132. 7 C 37. 1 K 61. 2 AP 85.2 AP 109.3 AN a133. 7 AP 38. 1 K 62. 2 C 86.2 AP 110.3 AN a134. 8 C 39. 1 K 63. 2 K 87.2 AP 111.3 K a135. 8 C 40. 1 C 64. 2 K 88.2 AP 112.4 K a136. 8 C 41. 1 C 65. 2 K 89.2 AP 113.4 K a137. 8 AP 42. 1 C 66. 2 K 90.2 AP 114.4 K a138. 8 AP 43. 1 K 67. 2 C 91.2 AP 115.4 K a139. 8 AP 44. 1 C 68. 2 C 92.2 AP 116.4 K st140. 1 K 45. 1 C 69. 2 K 93.3 AP 117.4 AP sg141. 1 K 46. 1 K 70. 2 K 94.3 AP 118.5 C st142. 2 K 47. 1 K 71. 2 AP 95.3 AP 119.5 AN sg143. 2 AP 48. 2 K 72. 2 AP 96.3 AP 120.5 AN st144. 3 K 49. 2 C 73. 3 AP 97.3 K 121.5 AN sg145. 3 C 50. 2 C 74. 2 AP 98.3 C 122.5 C st146. 4 K 51. 2 AP 75. 2 AP 99.3 C 123.6 K sg147. 5 AN 52. 2 K 76. 2 AP 100.3 C 124.6 K st148. 6 K 53. 2 AP 77. 3 AP 101.3 C 125.6 AP sg,a149. 8 AP 54. 2 AP 78. 2 AP 102.3 K 126.6 AP 55. 2 AP 79. 2 AP 103.3 K 127.6 AP 56. 2 AP 80. 2 AP 104.3 C a128.7 AP 57. 2 AP 81. 2 AP 105.3 K a129.7 AP Brief Exercises 150. 1 C 152. 2 P154.2 P156.2K 158. 5C 151. 2 AP 153. 2 AP 155.2 AP 157.4 AP 159. 6 AP sg This question also appears in the Study Guide. st This question also appears in a self-test at the student companion website. a This question covers a topic in an appendix to the chapter. Does FIFO follow the physical flow of goods?A FIFO method does not follow the physical flow of goods when costing an inventory. Based on the FIFO method, the first manufactured or purchased products will be sold or issued to the customer first; here, no physical goods are considered.
What is FIFO inventory costing method?What is the FIFO method? FIFO stands for first in, first out, an easy-to-understand inventory valuation method that assumes that goods purchased or produced first are sold first. In theory, this means the oldest inventory gets shipped out to customers before newer inventory.
What is the inventory costing method that follows the physical flow of the goods?FIFO is inventory cost method that follows the physical flow of the goods. If the perpetual inventory system is used, the accounting entitled Merchandise Inventory is debited for purchases of merchandise. Under the periodic inventory system, the MI account continuously discloses the amount of inventory on the hand.
Does LIFO match the physical flow of goods?Although LIFO provides a more accurate picture of your current inventory costs, it doesn't match up well with the physical flow of goods. In other words, the items you purchased most recently are not always the items you sell first. As a result, LIFO can lead to supply shortages and lost sales.
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Fifo is the inventory costing method that follows the physical flow of the goods. true false
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