FIFO Method — Quick Reference and Key Exercise Highlights

Perpetual inventory system uses the First-in, First-out (FIFO) method to value inventory sold and remaining on hand. The earliest costs on hand are assumed to be the ones sold first.
FIFO does not require tagging each item with a cost; costs are allocated from the BALANCE column when items are OUT (sold, used, or withdrawn).
When there are multiple cost prices in the BALANCE column, FIFO uses the oldest cost first for OUT transactions.
FIFO is suitable for: high-volume indistinguishable items, perishable goods, fashion/trends, and technology that becomes outdated quickly.

Cost of sales on sale: allocate the oldest costs from the BALANCE column to the sold quantity.
OUT transactions (Sales, Advertising, Drawings): use oldest cost prices first.
IN transactions (Purchases): add items at their supplier cost prices; these become the new latest costs in the BALANCE column.
FIFO in Sales Returns (customer returns): allocate cost using the latest cost prices in the OUT column (reverse FIFO).
FIFO in Purchase Returns: treated as OUT to supplier; cost price is the supplier’s credit note (not identified by FIFO, but recorded at the credit-note cost).

Sales (FIFO): if 20 units sold with two batches in stock, allocate from oldest batch first (earliest cost prices).
- Example: if 20 T-shirts on hand are 17 at 4.50 and 3 at 5.00, then all 17 from 4.50 are sold, and 3 from 5.00 are sold (total 20).
- Revenue example (per unit): 10 + GST 1 = 11; Revenue for 20 units = 20 imes 11 = 220.
- Cost of goods sold for this sale = 17 imes 4.50 + 3 imes 5.00 = 76.50 + 15 = 91.50.
Advertising/Drawings (FIFO): record OUT using the oldest cost, then adjust BALANCE.
- Step 1 (OUT): oldest cost price from BALANCE, e.g. 5.00 per unit.
- Step 2 (BALANCE): decrease the corresponding cost-price lot, keep newer lots intact.
Sales Returns (FIFO): treat as reversing the sale using the latest OUT cost price.
- Example rule: cost price for the return equals the latest cost price in the OUT column (e.g., 5.50).
Purchase Returns (FIFO): recorded as OUT; the cost price is the supplier's credit note value (not allocated via FIFO to the original itemized cost).

Inventory loss: adjust the inventory card to match the physical count; record as a loss in the IN or OUT as appropriate with the relevant cost from the BALANCE column.
Inventory gain: when physical count exceeds book balance, recognize gain using the cost prices from the BALANCE column.
Examples show losses/gains are possible between physical counts and the balances on the inventory card, and are adjusted using the FIFO cost prices visible in the BALANCE column.

Benefits:
- No need to label every item with a cost, so easier administration for many items.
- Applicable to all inventory types where labeling is impractical.
- Lower administrative costs than Identified Cost; still provides a faithful representation via verifiable source documents.
Trade-offs:
- FIFO can bias Cost of Sales toward older (lower) costs and on-hand inventory toward newer (higher) costs when prices rise.
- You may not know whether costs at sale time match the exact items purchased.

Example 1 (Sale, FIFO): 20 units sold; 17 units at 4.50, 3 units at 5.00; COGS = 17(4.50) + 3(5.00) = 91.50; Revenue = 20(10) + 20(1) = 220.
Example 3 (Advertising & Drawings, FIFO):
- After purchase on 25 Aug: BALANCE = 9 units at 5.00, 10 units at 5.50.
- Aug 26 OUT: 1 unit at 5.00; BALANCE becomes 8 at 5.00, 10 at 5.50.
- Aug 27 OUT: 5 units at 5.00; BALANCE becomes 3 at 5.00, 10 at 5.50.
Example 4 (Sales Return, FIFO): Return cost uses the latest OUT cost price, = 5.50; 2 units returned recorded in IN with 5.50 each.
Example 5 (Purchase Return, FIFO): Return to supplier recorded in OUT; cost price from supplier credit note (e.g., 5.50).
Inventory loss/gain examples (FIFO): physical counts can show discrepancies; adjust the balance to reflect the count using the cost levels in the BALANCE column.

Part B: FIFO inventory card for July (Deluxe Bar Stools)
- Start with 10 units on hand at cost 56.00 each on 1 July.
- Process chronological purchases and sales through July, applying FIFO to OUT transactions from the BALANCE column.
- End of July: physical count shows 15 units on hand with cost 64.00 each (Memo 38).
- FIFO card outcome (summary):
- Ending inventory value = 15 imes 64 = 960
- COGS for July is the sum of costs allocated to all units sold during July, per FIFO ordering from the BALANCE column.
Part C: Effect on profit if FIFO vs Identified Cost
- Rising prices environment (as in this example): FIFO assigns older, cheaper costs to COGS and newer costs to ending inventory.
- Consequence: under FIFO, COGS tends to be lower than Identified Cost (which may match specific batch costs), and Ending Inventory higher, leading to higher reported gross profit and potentially higher net profit for July when prices rise.
- Note: The exact numeric difference depends on the specific mix of purchases, sales, and ending inventory costs; the qualitative effect is that FIFO boosts reported profit in rising-price contexts while Identified Cost can show different results depending on which batches are sold.

FIFO = sell oldest costs first; no need to tag every item.
Apply FIFO to OUT for Sales, Advertising, Drawings; to IN for returns and new stock, and adjust BALANCE accordingly.
Sales Returns use the latest OUT cost price; Purchase Returns use supplier credit note cost.
Ending inventory under FIFO tends to reflect more recent costs in rising-price scenarios; COGS reflects older costs.
Practice problems often ask you to build an inventory card under FIFO and compare profit implications with Identified Cost.