One thing savvy investors want is a company that is good at managing assets. One of the most important assets in business is inventory. The way in which a company accounts for inventory can change the value of assets recorded on the balance sheet and expensed on the income statement. FIFO stands for first-in-first-out which means that the first inventory in is the first inventory out. Therefore, in periods of rising prices (which is often the case), the inventory sold is lower in value than the inventory being purchased.
Sort inventory by purchase date and then by price paid per unit of inventory. Let's say you purchased 500 doughnuts to sell through your business: The first 250 you purchased in the morning at a cost of $1 each, and the last 250 you purchased in the evening at a cost of $2 each.
Determine how many units were sold. Let's say you sold 400 doughnuts.
Calculate the value of units sold by finding the total cost of the units sold based on the price paid. Start with the inventory purchased first. For instance, the value of the first 250 doughnuts is $250 (250 x $1) and the value of the next 150 doughnuts is $300 (150 x $2). The sum of the two values is $250 + $300 or $550. This is the value of inventory used or the cost of goods sold.
Calculate the value of ending inventory. There are 100 doughnuts left at the end of the day (500 - 400). This inventory is the higher priced inventory valued at $2 per unit. The value of the doughnuts in inventory is $200 (100 x $2). This is the value of inventory as listed on the balance sheet.
Sort inventory by purchase date and then by price paid per unit of inventory. Let's say you purchased 500 doughnuts to sell through your business: The first 250 you purchased in the morning at a cost of $1 each, and the last 250 you purchased in the evening at a cost of $2 each.
Determine how many units were sold. Let's say you sold 400 doughnuts.
Calculate the value of units sold by finding the total cost of the units sold based on the price paid. Start with the inventory purchased first. For instance, the value of the first 250 doughnuts is $250 (250 x $1) and the value of the next 150 doughnuts is $300 (150 x $2). The sum of the two values is $250 + $300 or $550. This is the value of inventory used or the cost of goods sold.
Calculate the value of ending inventory. There are 100 doughnuts left at the end of the day (500 - 400). This inventory is the higher priced inventory valued at $2 per unit. The value of the doughnuts in inventory is $200 (100 x $2). This is the value of inventory as listed on the balance sheet.