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According to most of the companies, inventory is the largest portion of the assets which has a great significance in the presentation of balance sheet. Inventory can be defined as those assets which have been acquired by the company for sale purpose. These are assets which are being processed for sale or otherwise, they are used in the production of other goods. It is also known as the costing method.
First in first out method takes the assumption that units of the production which were received in the first instance are the first to be sold out. It gives the better indication of the value of ending inventory in the balance sheet, and also increases the net income. This is always good news to the company in that it increases net income. However, it increases the amount of tax the company has to pay.
The method‘s objective is to approximate the movement of the goods physically. The method closely approximates the specific identification of inventory and their units. Also the method does not permit manipulation of income because the enterprises are not in a position to pick a certain cost item, which should be charged to expense.
Like other methods of evaluating stock, first in first out method has got some merits too. Materials are drawn from the cost record in a systematic manner making the records easy to understand. It provides consistent and efficient material control. This is because it provides movement of materials in a continuous, orderly, and in a single file. It also makes the company free from any loss, or from decay of perishable goods. These types of goods are best suited for this method
As for the demerit of this method, it is more awkward if many frequent purchases are made at different prices and from several buyers at the same time. Also there are increased costing difficulties when returns to vendors have occurred.