What does FIFO method assume in terms of inventory?

The FIFO method, which stands for "First In, First Out," operates under the assumption that the oldest inventory items are sold first. This means that inventory listed on the balance sheet consists of the most recently acquired items. This methodology is significant for both accounting purposes and inventory management.

By selling the oldest items first, a business may reduce the risk of obsolescence or spoilage, which is particularly important for businesses dealing with perishable goods or materials that may become outdated over time. Additionally, in a period of rising prices, this approach can have favorable tax implications, as it leads to lower reported profits (since the cheaper, older inventory is sold first), which can result in tax savings.

This method contrasts with practices such as LIFO (Last In, First Out), where the most recent inventory is considered sold first, leading to entirely different cash flow and profit scenarios. Understanding FIFO helps businesses manage their inventory better, especially in industries where accurate cost flow assumptions are crucial for financial reporting.