Question 1

Does a business have to physically sell its oldest stock first to use the FIFO accounting method?

Accepted Answer

No, not necessarily. FIFO is an accounting assumption about the flow of costs, not a strict rule for the physical flow of goods. A business can physically sell any unit it chooses, but for accounting purposes, it will assume the cost of the first unit purchased is the first cost to be moved to 'Cost of Goods Sold'. However, for practical reasons like avoiding spoilage, many businesses do align their physical stock rotation with the FIFO principle.

Question 2

If FIFO reports higher profits during inflation, why wouldn't every business use it?

Accepted Answer

While higher reported profit can look good to investors, it also typically leads to a higher tax liability. Some businesses might prefer a valuation method that reports lower profit to reduce their tax bill in the short term (where permitted by accounting standards). Furthermore, the primary goal is to use a method that most accurately reflects the business's operations and cost flows. Consistency in applying an accounting method is also a key principle.

Question 3

Is FIFO the only method of inventory valuation?

Accepted Answer

No, it is one of several methods. Other common methods include AVCO (Average Cost). LIFO (Last-In, First-Out) is another method, but it is not permitted under International Financial Reporting Standards (IFRS), which the Cambridge A-Level syllabus follows. For the 9609 syllabus, a deep understanding of FIFO and its implications is the primary focus, with awareness of AVCO also being useful.

Inventory valuation

What you need to know

Inventory valuation