Advantages and Disadvantages of FIFO Method

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
1. 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.

2. 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.

3. 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

1. 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.

2. 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.

3. 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.