First in, First Out (FIFO) is a fundamental accounting method used to calculate net income and inventory valuation. In FIFO, companies assume that the oldest inventory items are sold first, regardless of their physical flow. For instance, a retail store that purchases 100 widgets at $1 each and later buys another 100 widgets at $1.25 each would assume that it sold 100 widgets from its initial purchase when it sells 100 widgets. This method provides a more accurate representation of the cost of goods sold and net income compared to other inventory valuation methods, such as Last in, First Out (LIFO) or weighted average cost.
FIFO is widely used in various industries due to its simplicity and adherence to the matching principle. It ensures that expenses are matched to the revenue generated in the same period. Historically, FIFO gained prominence during periods of inflation as it resulted in lower cost of goods sold and higher net income, which benefited companies by reducing their tax liability.