FIFO

FIFO is one of the two inventory costing conventions IAS 2 permits, the other being weighted average cost. It assumes the first cost in is the first cost charged out, which means cost of sales is built from the oldest purchases and closing inventory carries the most recent ones.

The word assumption is doing real work. FIFO does not describe which physical goods left the warehouse. For interchangeable units there is no fact of the matter to discover, so accounting picks a convention and applies it consistently. A company can operate a perfectly ordinary warehouse and still cost its inventory on any permitted basis.

In a period of rising input costs FIFO reports the higher profit, because the cheapest costs are the ones being charged. Its compensating virtue is on the balance sheet: closing inventory sits close to current replacement cost, which is what an analyst reading a balance sheet actually wants. That trade off, a slightly stale income statement against a current balance sheet, is exactly the one LIFO takes in the opposite direction.

The direction is conditional and worth stating as such. If input costs fall, FIFO charges the expensive old stock and reports the lower profit. Treating FIFO as the high profit method is a memorised rule that breaks the first time an interviewer picks a deflationary example.