FIFO inventory method explained, with examples

If you buy the same product several times at different prices, you need a rule for deciding what each unit you sell actually cost you. The FIFO inventory method, short for first in, first out, is the most widely used answer: it assumes the units you bought first are the ones you sell first. That one assumption decides your cost of goods sold, your gross profit and the value of the stock on your balance sheet. This guide explains how it works with a worked example, compares it with weighted average cost, and covers the mistakes that quietly make stock numbers wrong.

What the FIFO inventory method is

Every time you buy stock, you add a new cost layer: a quantity and the price you paid for it. Under FIFO, when you sell, the cost is taken from the oldest layer first. Once that layer is used up, the next oldest layer is used, and so on. Whatever is left in stock is valued at the most recent purchase prices.

FIFO is a costing assumption, not an instruction to your warehouse. You do not have to physically ship the oldest boxes first, although for food, medicines or anything with an expiry date you probably should. The method only decides which purchase price is matched against each sale.

It is accepted under both major accounting frameworks. IFRS allows FIFO and weighted average cost under IAS 2 Inventories, and specific identification for items that are not interchangeable. US GAAP, in FASB's inventory topic (ASC 330), allows FIFO and weighted average too, and also permits LIFO (last in, first out), which IFRS prohibits.

A worked FIFO example

A small distributor sells LED panels. In March it makes three purchases and one sale:

Date	Event	Units	Cost per unit	Total cost
Mar 1	Purchase	100	$10.00	$1,000
Mar 10	Purchase	150	$12.00	$1,800
Mar 20	Purchase	100	$13.00	$1,300
	Available for sale	350		$4,100
Mar 25	Sale at $20.00 each	200		Revenue $4,000

Under the FIFO inventory method, the 200 units sold take their cost from the oldest layers first:

all 100 units from the Mar 1 layer at $10.00 = $1,000
100 of the 150 units from the Mar 10 layer at $12.00 = $1,200

Cost of goods sold = $2,200. Gross profit is $4,000 − $2,200 = $1,800.

The 150 units left in stock are the newest layers: 50 units at $12.00 ($600) and 100 units at $13.00 ($1,300), so closing stock = $1,900.

The check that matters: cost of goods sold plus closing stock must equal the total cost of goods available. $2,200 + $1,900 = $4,100. Every dollar you paid is either in the profit and loss account as cost of sales, or still on the balance sheet as stock. Nothing is lost and nothing is counted twice.

Cost of goods sold vs closing stock

This split is the whole point of inventory costing. When you buy stock, it is not an expense yet; it is an asset. In double-entry terms, a purchase debits inventory and credits the supplier or the bank. Only when goods are sold does their cost move out of inventory and into cost of goods sold.

For the sale above, the system should post two entries:

Entry	Debit	Credit	Amount
The sale	Accounts receivable	Sales	$4,000
The cost of the goods sold (FIFO)	Cost of goods sold	Inventory	$2,200

If the second entry is missing or uses the wrong cost, your gross margin is wrong, and so is the stock figure on your balance sheet. Because the two always add up to the same total, an error in one is always mirrored in the other.

FIFO vs weighted average cost

The main alternative is weighted average cost. Instead of keeping layers, it blends all units into one average. In the example, $4,100 ÷ 350 units = about $11.71 per unit.

	FIFO	Weighted average
Cost of goods sold (200 units)	$2,200.00	$2,342.86
Gross profit	$1,800.00	$1,657.14
Closing stock (150 units)	$1,900.00	$1,757.14
Total	$4,100.00	$4,100.00

Both methods account for the same $4,100. They differ only in how it is split. With prices rising, FIFO matches older, cheaper costs to sales, so it shows higher profit and a closing stock value closer to current replacement cost. Weighted average smooths price swings. When prices fall, the pattern reverses.

A few points worth knowing:

Consistency matters more than the choice. Pick one method for similar items and keep it. Switching methods is a change in accounting policy, and for US tax purposes a change in inventory method generally needs IRS consent; see IRS Publication 538.
LIFO is a US-only option. It is not allowed under IFRS. Under US rules, a business that elects LIFO for its tax return must generally use it in its financial statements as well.
Stock is not carried above what it can be sold for. Under FIFO or average cost, both IFRS and US GAAP require inventory to be written down if its net realizable value falls below cost, for example for damaged or obsolete goods.

Why stock must never go negative

Suppose the records show 350 units but someone sells 400. Under FIFO there is no cost layer for the last 50 units, so the system has to guess, usually using the last known price or zero. Cost of goods sold is understated, profit is overstated, and when the next purchase arrives it has to be partly matched against a sale that already happened in a previous period.

Negative stock is almost always a symptom of something else: a purchase received but not entered, a sale entered twice, stock moved between locations without a transfer, or a miscount. The safe rule is that a sale cannot be posted for more units than the records show at that location. If the goods really are on the shelf, the fix is to record the missing receipt or transfer first, not to let the balance dip below zero.

Warehouses and racks: FIFO by location

Once you hold stock in more than one place, FIFO needs to know where each layer is. A business with a main warehouse and a showroom should be able to see that 60 units sit in Main, rack A-03, and 40 in the showroom, each with their cost layers.

Tracking by location gives you three things: pickers know where to go, a sale from one location cannot quietly consume stock that is physically somewhere else, and a stock transfer between locations moves units and their cost without touching profit, because nothing was sold. Cycle counts by rack also become practical, since you are counting a shelf, not the whole building.

BMS Prime's Inventory and Procurement module works this way: several warehouses with rack locations, FIFO costing, stock transfers and low-stock alerts, available on the Growth and Business plans.

Purchase order, goods received, vendor bill

Clean FIFO layers start with a clean buying process. The usual sequence is:

Purchase order: what you agreed to buy, how many and at what price. No accounting entry yet.
Goods received: what actually arrived, counted into a specific location. This is the moment the stock and its cost layer should be created. Many systems credit a "goods received, not yet billed" clearing account here, because the supplier's bill may not have arrived.
Vendor bill: the supplier's invoice. It is checked against the order and the receipt, which is called a three-way match, and then it credits accounts payable, clearing the receipt.

The three-way match catches the common problems: being billed for goods that never arrived, a price higher than agreed, or a quantity that differs from what was counted. It also prevents the same stock from being added twice, once on receipt and again on the bill. In BMS Prime, purchase orders, goods receipt and the three-way match are part of the same module, so stock and its cost follow from the receipt. If your buying still runs on email and spreadsheets, see our guide to the signs you have outgrown spreadsheets.

Common FIFO mistakes

Backdating receipts. Entering a purchase with an earlier date than a sale that already used later layers changes which costs that sale should have taken. Enter receipts promptly, with their real date.
Leaving out landed costs. Freight and import duties paid to get goods to your warehouse are part of their cost. Recording them as a general expense understates stock and distorts margins.
Adjusting quantity without cost. A stock adjustment that adds units with no cost creates a zero-cost layer that a future sale will consume, showing an inflated margin.
Mixing methods. Using FIFO in the stock system and an average in a spreadsheet means the two never agree.
Not reconciling stock to the ledger. The inventory account and the stock valuation report should show the same figure. Check it at every month-end close.

Get the purchase records right, keep stock from going negative, and the FIFO inventory method takes care of the rest: accurate cost of goods sold, a true gross margin and a stock value you can trust. When you are ready to try it on your own items, the getting started guide shows how to set up warehouses and buy through purchase orders, and the pricing page lists which plans include inventory.

Frequently asked questions

Is FIFO allowed under IFRS and US GAAP?

Yes. FIFO is accepted under both IFRS (IAS 2 Inventories) and US GAAP. Weighted average cost is also accepted under both. LIFO is the one that differs: it is prohibited under IFRS but permitted under US GAAP, and a US business that uses LIFO for its tax return must generally use it in its financial statements too.

Does FIFO mean I have to sell my oldest stock first?

No. FIFO is a costing assumption, not a rule about how you pick goods off the shelf. It assigns the oldest purchase costs to the first units sold, whichever physical units actually left. That said, for perishable or dated goods, selling the oldest stock first is good practice anyway, and in that case the costing matches the physical flow.

Does FIFO give higher profit when prices are rising?

Usually, yes. When purchase prices rise, FIFO charges the older, cheaper costs to cost of goods sold, so gross profit and closing stock are higher than under weighted average or LIFO. Higher reported profit can also mean higher income tax. When prices fall, the effect reverses.

What is the difference between FIFO and specific identification?

Specific identification tracks the actual cost of each individual unit, which suits high-value items with serial numbers, such as vehicles or equipment. FIFO works with layers of identical units bought at different prices and assumes the oldest layer is used first. For everyday stock of interchangeable items, FIFO is far more practical.

How often should I count physical stock under FIFO?

A full count at least once a year is the minimum most accountants expect, and many businesses also run cycle counts, checking a few items or racks every week so the whole warehouse is covered over a period. Any difference found is posted as an adjustment, so the stock records and the ledger keep matching what is really on the shelves.