FIFO is the term used in the context of inventory management, full form of FIFO is First In First Out. It refers to that method through which raw materials for final production are used in order of their entry into storehouse, so the raw materials which came first will be used first and materials which came last will be used last. Given below are some of the advantages and disadvantages of FIFO Method –
Advantages of FIFO
- The biggest advantage of this method is that it very simple to understand and operate and therefore it does not require any specialized personnel and hence chances of mistake are less under this process.
- Since the materials which are brought first are used for production there is less wastage on account of deterioration of material and hence it results in effective utilization of companies resources.
- In this method at the end of financial year when the company will calculate closing stock it will reflect the current market valuation of the stock and hence closing stock will reflect the true position of the company at the end of financial year.
Disadvantages of FIFO
- The biggest disadvantage of FIFO method is that it result in overestimation of company’s profit when there is inflation because during inflation the prices of raw materials are rising rapidly but since company is using old raw material it results in understatement of production cost leading to overestimation of profits of the company and hence it does not present the true picture of company’s financial position.
- Matching concept of accounting is violated in first in first out method because according to matching concept expenses incurred in an accounting period should be matched with revenues during that period and in FIFO method since raw materials of previous period are used for current year production it result in violation of this accounting concept.
- During inflation FIFO method will result in higher profits because of lower production cost and higher selling price which in reality is not correct as raw materials are purchased at much higher price when one takes into account recent purchase and hence company will be forced to pay higher taxes on higher profit leading to lower real profits for the company when one takes into account recent purchases of raw material.