Which inventory valuation method assumes the first items purchased are the first sold?

The First-In-First-Out (FIFO) inventory valuation method is based on the assumption that the first items purchased are the first ones to be sold. This means that the cost of the oldest inventory items is recognized first when calculating the cost of goods sold (COGS). As a result, under FIFO, the remaining inventory consists of the more recently purchased items.

This method is particularly useful in industries where inventory items have a shelf life or can become obsolete over time, as it aligns with the natural flow of goods in many situations. For example, in a grocery store, perishable goods like fresh produce are sold before they spoil, making FIFO a logical choice for reflecting true costs and maintaining accurate financial reporting.

The implementation of FIFO can significantly impact financial statements. In times of rising prices, FIFO results in lower COGS and higher taxable income compared to other methods, which can influence a company's cash flow, tax liability, and profitability. It also provides a clearer view of the value of the ending inventory on the balance sheet, as it reflects more current purchase prices.

In summary, using FIFO helps maintain logical flow and presents a realistic view of profitability and inventory values, making it a preferred method for many businesses.