Perpetual FIFO (First In, First Out) is an inventory valuation method that assumes the first goods added to inventory are the first ones to be sold. The “perpetual” aspect refers to the continuous updating of the inventory records every time a sale or purchase is made.
Under the FIFO method, it’s assumed that the oldest inventory items are sold first. This means that the cost of goods sold (COGS) is based on the cost of the oldest items in inventory, while the value of the remaining inventory is based on the cost of the newest items.
Let’s illustrate with an example:
Imagine a grocery store that sells apples. They buy 100 apples on Monday for $1 each, then another 100 apples on Tuesday for $1.10 each.
Under the perpetual FIFO method, if a customer comes on Wednesday and buys 150 apples, the grocery store assumes that the first 100 apples sold were from Monday’s batch (costing $1 each) and the next 50 were from Tuesday’s batch (costing $1.10 each).
So, the COGS for these 150 apples would be $100 (for Monday’s batch) + $55 (for Tuesday’s batch) = $155.
The value of the remaining inventory (50 apples) would be $55 (50 apples x $1.10 each).
This approach reflects the natural flow of inventory for many types of businesses, especially those dealing with perishable goods. Moreover, during periods of inflation, using FIFO results in a lower COGS and higher inventory value, which leads to higher net income and taxes compared to other methods like LIFO (Last In, First Out).
Example of Perpetual FIFO
Let’s consider a detailed example using the perpetual FIFO method:
Let’s assume we have a small business selling handmade candles. Here’s a record of their inventory purchases and sales over a month:
- January 1: The business purchases 10 candles at $5 each (Total cost: $50).
- January 10: They purchase another 15 candles, but due to increasing wax prices, these cost $6 each (Total cost: $90).
- January 15: The business sells 18 candles.
Under the perpetual FIFO method, the business assumes that the first candles they sell are the ones they purchased first. So, of the 18 candles sold:
- The first 10 candles are assumed to come from the January 1st batch, costing $5 each.
- The next 8 candles are assumed to come from the January 10th batch, costing $6 each.
The Cost of Goods Sold (COGS) would be calculated as follows:
- For the first batch: 10 candles x $5/candle = $50
- For the second batch: 8 candles x $6/candle = $48
- So, the total COGS = $50 (from the first batch) + $48 (from the second batch) = $98
The remaining inventory would be:
- 7 candles from the January 10th purchase (15 purchased – 8 sold), valued at $6 each. So, the total value of remaining inventory = 7 candles x $6/candle = $42
So, after the sale on January 15, the business records COGS of $98 and has $42 worth of inventory remaining, according to the perpetual FIFO method. The inventory record and COGS are updated immediately after the sale, which is the “perpetual” part of the perpetual FIFO method.