FIFO in periodic inventory system

The main goal of any business is to make a profit, and profit is determined by the formula: Revenues - Expenses. For companies engaged in trading or manufacturing, one of the largest cost items is the cost of inventory sold.

Cost of goods sold (COGS) is the direct cost of producing goods sold by a company. This amount includes the cost of the materials and labor that are directly used in the production of the goods. It does not include indirect costs, such as distribution costs and sales agent fees.

IAS 2 provides the following main methods for determining the cost of inventories

- Specific identification method;

- Weighted average cost method;

- FIFO method.

The use of these methods to estimate the cost of goods sold affects the company's profit margin.

In addition, every company needs a useful and reliable system for determining both the quantity and value of inventory. The two main systems of quantitative inventory accounting include periodic and continuous inventory accounting.

In this article, we will look at how the FIFO method is used in the periodic system

1.      Periodic inventory system

Under this system of inventory accounting, inventory on hand is counted periodically at the end of the accounting period. Detailed records of inventory movements and inventory on hand during the period are not maintained. And the opening balance at the beginning of the reporting period is determined by the inventory balance at the end of the previous reporting period, obtained through an inventory.

The general scheme of periodic inventory accounting is as follows:

The cost of inventories sold can be represented by the following diagram:

To arrive at the cost of goods sold at the end of the period, the cost of physical inventory is subtracted from the cost of inventory available for sale. At the end of the accounting period, entries are made to clear the beginning inventory (inventory at the end of the previous period) and to add the ending inventory (inventory at the end of the current period). These are essentially the only entries made to the Inventory account for the entire period. Therefore, the amount of inventory on hand is only accurate at the balance sheet date. As soon as purchases are made, this amount becomes the previous period's figure and remains so until a new inventory amount is entered at the end of the next accounting period.

This inventory system is quite common among small businesses because it does not require much work, but it is gradually  losing popularity due to the spread of computers. For large companies, such an accounting system is not preferable because it can lead to lost sales or high operating costs.

2.      FIFO (First-In-First-Out)

The first-in, first-out (FIFO) method assumes that those items of inventory that were purchased or produced first are sold first. Accordingly, the items remaining in inventory at the end of the period were purchased or produced last.

The FIFO method is typically used for storage of products that have a very limited shelf life, but not only for these products.

This method assumes that goods are used/sold in the order in which they are purchased and that the remainder of the inventory is the last purchase.

3.      FIFO method - periodic accounting

If a company uses a periodic accounting system and valuates its inventory using the FIFO method, how does this work in real data?

To illustrate, let's look at the following example.

Let's say that during a period we purchase the same item on different dates at different purchase prices and sell a certain amount of the item:

There is no difficulty in calculating the quantity. But how do we calculate the cost of goods sold?

First, let's calculate the cost of purchased goods, which is easy to do:

Now we need to calculate the cost of inventory at the end of the period.

Since the FIFO method assumes that inventory purchased first is sold first and inventory remaining at the end of the period is purchased last, the cost of inventory at the end of the period is:

As a result of our calculations, we find that cost of sales is equal to: 439000-271000 = UAH 168000.00

4.      Periodic inventory accounting system in ERP ODOO

What settings do you need to make to properly configure periodic accounting when using the Odoo system? 

First of all, you have to keep in mind that Odoo supports two inventory accounting systems: periodic and continuous. Accounting settings are defined at the product category level:

Each product entered into the system must belong to a specific category. This is indicated in its card.

As the product moves through the warehouse, the system does not expect any accounting entries to be made, as was the case with the perpetual accounting system. However, you can always see the balances at any given date and the cost of those balances through warehouse reporting. With the right accounting settings, you can also see the purchases made from suppliers for a given period. At the end of the period, you will need to make manual journal entries to record the cost of the inventory sold.