What does FIFO in inventory valuation assume?

FIFO, which stands for "First In, First Out," is an inventory valuation method that assumes the oldest inventory items are sold first. This approach is based on the idea that products that are received or manufactured earlier are the first to be used or sold. As a result, the costs associated with the oldest inventory are reflected in the cost of goods sold (COGS), while the remaining inventory consists of the newer, potentially higher-cost items. This method can be particularly advantageous in times of rising prices, as it can lead to a lower COGS and thus a higher reported profit, aligning with actual inventory flow in many businesses.

The assumption inherent in FIFO directly impacts financial statements, taxes, and cash flow, making it crucial for businesses to choose the inventory method that best reflects their operational realities.