What does FIFO mean in inventory accounting?

FIFO stands for "First In, First Out," which is a method used in inventory accounting. This approach is based on the assumption that the oldest inventory items are sold or used first. This means that the costs associated with older inventory are accounted for before the costs of newer inventory.

In practice, FIFO helps businesses accurately reflect the cost of goods sold, especially in times of inflation, as it typically results in lower cost of goods sold and higher ending inventory values. This method aligns better with the physical flow of goods for many types of inventory, as in most cases, older items are sold before newer shipments.

This accounting method is particularly beneficial for understanding profit margins over time and for tax considerations, since the lower cost of goods sold can lead to higher reported profits. Therefore, FIFO is a vital concept in inventory management and accounting practices.