Perpetual FIFO definition
/What is Perpetual FIFO?
Perpetual FIFO is a cost flow tracking system under which the first unit of inventory acquired is presumed to be the first unit consumed or sold. In addition, this cost flow occurs under a perpetual inventory system, where inventory inflows and outflows are recorded in the inventory records as soon as transactions occur. There is no difference between the resulting charge to the cost of goods sold if a perpetual inventory system or a periodic inventory system is used.
Perpetual FIFO is one of the most common cost flow tracking systems in use today, because it accurately reflects the actual flow of goods through a business.
Impact of Perpetual FIFO
In an inflationary environment, perpetual FIFO will result in the lowest possible cost of goods sold and the highest possible ending inventory valuation. This is because the oldest items in inventory were presumably purchased at the lowest prices, and are used first. This means that the cheapest items in stock are charged to expense first, while the newest and most expensive items are retained in stock. The net effect is that your business will maximize the amount of its reported profits. The reverse impact occurs in a deflationary environment (though this is a relatively rare event).
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Advantages of a Perpetual FIFO System
Using a perpetual FIFO system offers several advantages, particularly for businesses that manage large or diverse inventories. Below are the key benefits:
Accurate real-time inventory tracking. The perpetual system continuously updates inventory records for every transaction, providing real-time insights into stock levels. This helps businesses make informed decisions regarding reordering and sales.
Cost assignment efficiency. Under FIFO, the cost of goods sold is calculated using the cost of the oldest inventory first. This is particularly beneficial in times of inflation, as older, lower-cost inventory is expensed first, leading to a higher gross profit (assuming prices are rising).
Simplified accounting compliance. FIFO is widely accepted under both International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), making compliance straightforward.
Better cost visibility. FIFO provides a clear and straightforward method of calculating inventory costs. It aligns well with physical inventory flow in many industries, ensuring the financial records match the actual movement of goods.
Operational efficiency. A perpetual system reduces the need for frequent manual counts, saving time and labor. This is particularly useful for businesses with high transaction volumes.
In summary, a perpetual FIFO system combines the benefits of continuous inventory tracking with the simplicity and strategic advantages of FIFO valuation, making it a preferred choice for many businesses looking to optimize inventory management.