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First-In, First-Out (FIFO) in Plain English
“First in and first out” means you record the cost of your oldest inventory items first when calculating cost of goods sold (COGS). In practice, goods purchased or produced earliest leave the warehouse—or at least the accounting records—before newer inventory. This makes FIFO the mirror image of Last In, First Out (LIFO), which is prohibited under IFRS and Canadian tax law.
Businesses often use the FIFO method of inventory valuation because it lines up with physical flow: no one wants stale bread or outdated electronics hanging around. By pairing physical rotation with FIFO accounting, you get cleaner records, less spoilage, and easier audits.
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Why FIFO Beats LIFO for Most Canadian Businesses
| Reason | FIFO Advantage |
| Compliance | Accepted under both International Financial Reporting Standards and Generally Accepted Accounting Principles (GAAP). LIFO isn’t. |
| Financial reporting | Shows higher ending inventory on the balance sheet during inflation (newer, higher costs remain). |
| Transparency | Investors understand that older costs leave first, making the income statement easier to read. |
| Global trade | If you sell across borders, IFRS requires FIFO or weighted average—never LIFO. |
Because newer purchases stay in stock, FIFO can create higher profits on paper in a rising- price market. That boosts ratios and keeps lenders happy, even though it can also increase your taxable income.
FIFO Formula and Cost Flow—Step by Step
The FIFO cost formula is simple:
Step 1: List each purchase batch with quantity and unit cost.
Step 2: Match sales quantities to the oldest batch until those units run out.
Step 3: Continue assigning costs from the next-oldest batches until you’ve covered all units sold.
Step 4: Add those costs → COGS. Leftover costs → remaining inventory.
Illustrative grid
| Batch | Units | Unit Cost | Cost Layer Used in COGS? |
| Opening stock | 100 | $10 | Yes (oldest) |
| Purchase A | 80 | $11 | Partially (70 units) |
| Purchase B | 60 | $12 | No (all 60 stay in stock) |
COGS = (100 × $10) + (70 × $11) = $1 770
Ending inventory = (10 × $11) + (60 × $12) = $830
FIFO vs. Weighted Average Cost—Side-by-Side
| FIFO | Weighted Avg. | |
| COGS in inflation | Lower | Mid-range |
| Ending inventory | Higher | Mid-range |
| Record-keeping | More detailed (batch level) | Simpler (one average cost) |
| Impact on gross profit margin | Greater swing with price changes | Smoother over time |
| Best for | Perishables, fashion, electronics | Commodities, low-variety SKU |
Where FIFO Appears on Financial Statements
Income statement (P&L) – FIFO COGS uses older (cheaper) costs, so gross profit often looks bigger.
Balance sheet – Inventory is listed at the newer, higher purchase prices, reflecting current replacement cost.
Cash-flow statement – A higher reported profit may raise operating cash flow (indirect method), but don’t forget the cash actually left your bank for newer inventory earlier.
Taxable Income, Income Taxes, and CRA Compliance
Because FIFO leaves newest inventory on the shelf, it lowers COGS when prices rise—boosting profit and, therefore, income taxes. Canadian companies must plan for this cash hit:
- Compare FIFO or LIFO? Not an option—First In First Out or Average Cost are your choices.
- Watch taxable spikes. If raw materials jump in Q4, you might pre-buy in Q3 to smooth expenses.
- Track deductions: freight-in, import duties, and raw materials are part of inventory costs under both IFRS and CRA guidelines.
Real-World FIFO Examples by Industry
(a) Apparel Retailer
When cotton prices rise, FIFO keeps older, cheaper T-shirt costs in COGS and leaves pricey new stock on the rack. Margin looks healthy now—but the higher cost of sales hits next season if prices stay up.
(b) Craft Brewery
Grain bought in March is brewed first, so FIFO reflects physical flow. Inflation in hops shows up later in COGS, giving brewers lead time to tweak pricing.
(c) Food Distributor
Oldest potatoes ship first to avoid spoilage. Accounting FIFO plus warehouse FIFO keeps both financial reporting and real-world logistics aligned.
Software Tips to Automate FIFO Inventory Valuation
- Cloud inventory apps (Katana, Cin7) attach batch numbers and automate the fifo cost formula.
- POS integrations – Sales subtract units automatically, maintaining correct COGS layers.
- ERP alerts – Warn when a batch nears expiry or when the average accounts receivables cycle slows, tying working-capital data to inventory.
Common FIFO Mistakes and How to Fix Them
| Error | Result | Fix |
| Mixing FIFO and average
cost in one period |
Messy audit trail | Choose one method and
stick with it all year. |
| Omitting freight-in | Understated inventory C COGS | Add landed costs to
each batch on receipt. |
| Error | Result | Fix |
| Ignoring shrinkage | Inflated asset value | Do regular cycle counts and record write-offs to COGS. |
| Copy-pasting retail price as cost | Overstated inventory | Always record cost not MSRP. |
Key Takeaways
- FIFO is the first in first out method inventory strategy that sends oldest costs to COGS.
- During inflation, FIFO reports higher profits but can raise your tax bill.
- Accepted by financial reporting standards (IFRS) and GAAP, FIFO delivers cleaner books for lenders and investors.
- Automation tools reduce manual errors and keep your financial statements accurate.
Frequently Asked Questions
Does FIFO guarantee higher profit every year?
Only when purchase costs trend upward. Falling prices flip the effect.
Is FIFO allowed for tax in Canada?
Yes. LIFO isn’t. FIFO and Average Cost comply with CRA.
Can FIFO work for digital products?
Digital items have no batches; use Average Cost instead.
How often should I reconcile inventory under FIFO?
At least quarterly; monthly if margins are tight or items spoil.
Will FIFO hurt cash flow because of higher taxes?
It can. Forecast tax payments so cash doesn’t surprise you.
Key References
- CPA Canada – “Inventory Valuation Methods and Tax.”
- CRA – Inventory valuation
- Investopedia – FIFO overview and examples.
- Xero Guide – FIFO in cloud accounting.
- BDC Article – “Managing Supply Costs When Prices Rise.”
