Accounting using the FIFO method. FIFO method: definition, application

If you are serious about getting into trading, you will have to choose which costing method to use. Such a seemingly simple question - how to write off sold goods - can have a serious impact on how your trade will develop. In this material we will look at all methods of cost calculation , evaluate the advantages of each, and also tell you when it is better to use which one.

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The law allows three methods of assessment and calculation - by the cost of each unit of goods, by the average cost and by the FIFO method (English: “first in, first out”). Each of them will give different indicators for business profitability, and therefore for tax and management accounting. Let's figure out what the difference is.

At the cost of each unit

As the name implies, this method assumes that the cost of each specific product is taken into account in the calculations. This system is used when trading unique and expensive goods, when accuracy is important. For example, it is suitable for those who will sell cars, art or jewelry. It is logical that when a product is piecemeal, and one cannot easily replace another, exactly the price at which it was delivered is entered into accounting when writing off inventory items. This method also assumes that it is always clear from which specific delivery the goods sold came from.

What property is the FIFO method applicable to?

The activity of an enterprise is impossible without the purchase of assets involved in the production and sales cycle. A group of such property is called the organization's inventories. Inventories are assets that can be used in the form of materials or resources for the manufacture of products or further resale. These include:

• materials and raw materials;
• work in progress items;
• finished products in warehouse;
• goods purchased for sale;
• shipped goods;
• expenses written off for future periods;
• farmed and fattening livestock;
• other supplies and expenses of a similar nature.

Inventories are written off from the warehouse on a monthly basis and sent for sale or production. To account for such a business transaction, one of the methods is used, including the FIFO method. The procedure for registering the receipt and release of inventories is regulated by the accounting policy.

Peculiarities

FIFO is a method that implies that the accountant takes for granted that inventories are not spent in an instant, but are written off gradually. Inventory leaves the warehouse at different intervals. Simultaneously with the posting describing the transfer of material assets, the cost of the property must be written off. At what price should an accountant record retiring inventory?

The FIFO accounting method implies that the oldest supplies need to be written off first at the actual cost of the first receipt. At the same time, not all enterprises follow the first part of the condition, i.e. the main criterion is still the use of the prices of the initial batch for the first release into production/sales. In fact, materials from any parish can be written off. For disposal of the second and further batches, the cost is determined at the prices of the second, third, and so on in order of delivery.

The FIFO method is directly related to changes in market prices. With rising inflation, the use of the method threatens to increase the amount of income tax. In the opposite situation, if the value of inventories decreases, the rate of liabilities on income is guaranteed to decrease.

Areas of use

Calculating the cost of inventories according to FIFO, which is based only on a chronological framework, allows you to successfully use the method for accounting in enterprises of various industries. For example, it can be used by wholesale trading companies, industrial enterprises, and logistics organizations. The only exception is retail trade, the accounting of which requires writing off costs at the exact price of individual products. FIFO is a method that cannot provide this.

Despite the universal approach of the method to assessing inventories, not every enterprise is able to function using it. When deciding to create one or another method for calculating cost when writing off inventory, you should carefully weigh the positive and negative aspects.

Application in accounting

In the absence of an expiration date, there is no significant difference in the product release.
Therefore, the choice in favor of one method or another is often speculative, having significance only within the framework of accounting and bookkeeping.

In other words, knowing the priority allows an accountant or manager, if necessary, to determine exactly which product was released.

The FIFO method allows you to track the progress of units of production.

LIFO is used when it is justified by external factors.

An example most often given is a diagram with plates lying in a stack. Since all the goods are the same and practically not subject to spoilage, it makes sense to take the top plate for sales or other needs, i.e. which arrived last.

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FIFO write-off method: advantages

The use of this method will appeal not only to accountants, but will generally have a positive impact on the activities of the enterprise. The most advantageous and convenient qualities for maintaining warehouse accounting using FIFO are:

• simplification of collection and reflection of information and high productivity of the accountant;
• ideal compatibility taking into account perishable products;
• ensuring lower levels of stale reserves;
• increasing the economic value of the enterprise, which may be beneficial for certain categories of legal entities;
• high profit margins can attract investors and characterize the company's creditworthiness from the best side.

The FIFO valuation method has an irreplaceable practical value: simplicity of accounting organization. To fully understand this advantage, consider a hypothetical example, without numerical data:

Enterprise N receives MPZ in small batches. As they are used, the cost of each of them increases, and the reserves themselves are consumed unevenly. At the end of the month, it becomes necessary to take into account the balances from each delivery and the amount of inventory consumed. With the usual accounting methodology, the accountant will have to perform many difficult and routine operations: balances must be calculated for each batch separately, and their value only increases in the next period. FIFO is a method that allows the accountant to write off balances at the cost of the last batch from the end. This makes the calculations much simpler.

LIFO method in practice

Let's imagine that your store ordered three shipments of goods within the last three months. In table form it will look like this:

Let's make a calculation. So, at the end of the last month of March, you sold goods for 40 thousand rubles, while it cost you 30 thousand rubles. In total, it turns out that your net profit is about 10 thousand rubles. Quite a bit, compared to calculations for previous periods: for the month of February, net income will be 20 thousand rubles, and for January, when selling all remaining products, it will be 30 thousand rubles.

Disadvantages of the FIFO technique

No matter how universal the method may seem, it still has its negative sides, which can affect the activities of the enterprise. These include:

• ignoring inflationary processes when accounting, which leads to an overestimation of the cost of inventories;
• an increase in the amount of tax liabilities due to an increase in the size of the organization’s financial results;
• complication of the cost planning process;
• deterioration in enterprise management and forecasting of future activities.

Perhaps all of the above points boil down to the first: insufficient attention to inflation processes. Uneven consumption of inventories can lead to the write-off at a much lower price of property that originally cost many times more. The result is inflated indicators that confuse management when drawing up a further development plan.

To avoid negative consequences, first of all, do not forget about the features of the method when analyzing the results of financial activities and planning the further development of the enterprise. Before using the FIFO method, it is advisable to carefully consider its need for an organization's accounting.

Calculation rules

FIFO is one of the methods established by PBU for accounting for inventories. To organize the correct inventory write-off process, you should adhere to the rules for its application:

• Not only incoming and expending inventories, but also their balances in the warehouse are subject to calculation;
• unused inventories are subject to accounting once at the end of the month;
• an enterprise has the right to use a simple and modified FIFO form.

The modified accounting method involves using the average cost of inventories, which is recalculated monthly, when calculating.

FIFO or average cost - which is better?

Both of these methods work quite well. However, FIFO is considered more accurate than the average cost method. It is especially beneficial in terms of taxes if the price of the goods you purchase is constantly decreasing. Then the cost of the written-off goods will be the greatest, and the balance will be the minimum. Therefore, the answer to the question of which is better, FIFO or average cost, in most cases will be the first option.

FIFO method: calculation example

It is best to fully understand the essence of the method in a visual way. Let's consider an example at an enterprise with a given condition: the balance of inventories at the beginning of March 2021 was 600 USD. e. (60 units of inventory at a cost of $10). The company received 3 deliveries:

• the first was 900 USD. e. (10 units of 90 c.u.);
• second – 10,500 USD e. (100 units at 105 c.u.);
• third – 3000 USD e. (20 units for 150 cu).

Write off inventories and calculate the balance at the end of the month.
We will place the calculation results in a table. Data on the movement of MPZ

According to the task data, in the reporting month there were a total of 190 units of inventories in the warehouse. As a result of business activities, 180 units were consistently written off. The calculations used prices starting from the first delivery. In total, at the end of the period, 10 units of inventory remained, which are subject to accounting at the cost of the last delivery (in this case, the third).

The FIFO method is very simple and easy to use, although it entails some negative consequences. Nevertheless, with a competent approach to establishing the method of warehouse accounting of inventories necessary for an enterprise, it is possible to minimize negative manifestations and achieve a maximum positive impact on the development of the economic activity of the enterprise.

Let's say goodbye to LIFO

Since January 1, 2008, the LIFO method has been excluded from the accounting rules for inventory. The accountant is left with three valuation methods. Let's try to figure out how to take into account the changes and choose the most profitable method for the company to write off goods.

L. Izotova In an effort to bring Russian standards closer to international ones, the Ministry of Finance issued order No. 26n dated March 26, 2007.
Officials made changes to the Regulations on accounting and reporting (PBU 5/01) “Accounting for inventories” and to the Guidelines for accounting for inventories. LIFO has been removed from the methods of determining the actual cost of material resources. This method has not been used for a long time in many Western countries. For example, in the UK there is a special bulletin SSAP 9 “Inventories and long-term contracts”. It states that the LIFO method does not provide an acceptable ratio of accounting costs to actual costs of the reporting period and is unsuitable for external reporting. Why does this method not suit financiers?

Attention
In tax accounting, the LIFO method still remains. It is used when writing off raw materials and materials for production (clause 8 of Article 254 of the Tax Code), when selling purchased goods (subclause 3 of clause 1 of Article 268 of the Tax Code) and when selling or otherwise disposing of securities (clause 9 of Article 280 NK). In conditions of inflation, this method allows you to minimize profits, and therefore reduce income tax payments.

However, if the company continues to use the LIFO method in tax accounting next year, temporary differences will inevitably arise. However, it is possible that legislators will not stop and will remove this method of assessment from the Tax Code.

At the price of the latest
LIFO is an abbreviation of the English expression “Last In, First Out”, which translates as “last in, first out”. That is, according to the LIFO method, the inventory that was received last is written off first. Consequently, the actual cost of the balance of inventory at the end of the month will be the sum of the cost of early acquisitions of inventories (clause 20 of PBU 5/01, clause 77 of the Methodological Guidelines for Accounting for Inventories).

In conditions of rising prices using the LIFO method, the accountant will first of all take into account modern, and therefore more expensive, inventories. Accordingly, material costs in the cost of goods sold will be overestimated, and profit will be underestimated. At the same time, the amount of inventory shown on the balance sheet will be based on historical prices. And this can confuse users. The opposite situation will occur with a constant fall in prices. In this case, the accounting profit will be overstated.

There is one more nuance. In practice, inventory items are most often used in the order in which they were acquired. That is, they first try to “sell” earlier goods or materials. So the data calculated using the LIFO method will be very far from “life”. And they are unlikely to be useful, for example, for management accounting.

There are other methods for estimating the cost of inventory in accounting. They are listed in paragraph 16 of PBU 5/01 (approved by order of the Ministry of Finance dated June 9, 2001 No. 44n):

• at the cost of each unit;
• at average cost;
• at the cost of the first acquisition of inventories (FIFO method).

Let's look at these methods in more detail. Each of them has its own specific application, its pros and cons. Our task is to understand which method is more profitable to use in a particular case. This is especially important for those firms that currently use LIFO. After all, starting next year they will have to choose a different method.

attention
Order of the Ministry of Finance dated March 26, 2007 No. 26n not only abolished the LIFO method, but also made another change to PBU 5/01. True, it is rather technical in nature. The fact is that the current version of paragraph 4 of PBU 5/01 states that this standard “does not apply to assets used for a period exceeding 12 months.” Consequently, such property cannot be accounted for as inventories. Even if its cost, for example, is less than 20,000 rubles. However, another Regulation states that assets “with a value within the limit established in the organization’s accounting policy, but not more than 20,000 rubles per unit, may be reflected in accounting and financial statements as part of inventories” (clause 5 of PBU 6 /01). It turns out to be an inconsistency. It was this that was removed by specialists from the financial department. Since 2008, the phrase about assets with a useful life of more than 12 months has been excluded from paragraph 4 of PBU 5/01.

One of the three
Methods “at the cost of each unit” is used for piece accounting. It is recommended “for inventories used by the organization in a special manner (precious metals, precious stones, etc.), or inventories that cannot normally replace each other” (clause 17 of PBU 5/01). This method is justified if the company works with single, expensive goods. It can also be used by construction companies performing work on special orders (clause 4.14.2 of the Standard Methodological Recommendations for Planning and Accounting for the Cost of Construction Work, approved by Order of the Ministry of Construction dated December 4, 1995 No. BE-11-260/7). The piece counting method provides accurate data, but it is very labor-intensive and is only possible with a small range of materials. Most often in practice, the “average cost” method is used. In this case, the assessment of inventories “is made by dividing the total cost of inventories by their quantity, consisting respectively of the cost and the amount of balance at the beginning of the month and the inventory received during a given month” (clause 18 of PBU 5/01). The method is convenient and does not cause much trouble. However, the data is averaged and often does not reflect the real picture.

The third method is FIFO - the direct opposite of the LIFO method. That is, the stocks that arrived first are written off first. The actual cost of the balance of materials at the end of the month consists of the cost of the most recent acquisition of inventories (clause 19 of PBU 5/01, clause 76 of the Guidelines for accounting of inventories). Therefore, the balance sheet data turns out to be quite consistent with reality, and they can be used to make management decisions. True, FIFO also has disadvantages. For example, in conditions of inflation, the value of accounting profit will be significantly higher than real indicators. And if prices fall, on the contrary, financial results will be greatly underestimated.

Despite the fact that changes in accounting rules take effect only from the beginning of next year, it is better to take care of revising accounting policies in advance.