Accurate application of the First-In, First-Out inventory valuation approach necessitates diligent tracking of costs associated with the initial units acquired. This system assumes that the earliest goods purchased are also the first ones sold. Consequently, the cost of those earliest purchases is what will be recorded as the cost of goods sold. For example, if a business bought 100 units at $10 each in January and another 100 units at $12 each in February, and then sold 150 units in March, the cost of goods sold would be calculated as 100 units x $10 + 50 units x $12, resulting in a value of $1600. Remaining inventory would then be valued at the later, more recent costs.
This method offers several advantages, primarily in its alignment with the actual physical flow of goods for many businesses, particularly those dealing with perishable items or products subject to obsolescence. Correct implementation often leads to a more realistic portrayal of inventory value on the balance sheet, reflecting current market prices rather than outdated costs. Historically, this approach has been favored for its simplicity and ease of understanding, which can streamline accounting processes and improve the accuracy of financial reporting.
