2 Why inventory changes matter?

Inventory changes refer to the difference between the beginning and ending inventory levels of a joint product. Inventory changes affect the allocation of joint costs, because they imply that some units of output were produced in a prior period but sold in the current period, or vice versa. Depending on the method of allocation, inventory changes can create distortions in the unit costs and gross margins of the joint products.

3 How FIFO method works?

The FIFO method stands for first-in, first-out, and it assumes that the units of output sold in the current period were produced in the same period, unless there is a shortage of inventory. In other words, the FIFO method matches the costs of the earliest units produced with the revenues of the earliest units sold. The FIFO method allocates joint costs based on the physical output of the current period, ignoring any inventory changes.

4 How to apply FIFO method?

To apply the FIFO method, you must first calculate the physical output of the current period by adding the ending inventory to the sales and subtracting the beginning inventory. Then, divide the total joint costs of the current period by the physical output to calculate the joint cost per unit. After that, multiply the joint cost per unit by the sales of each product to allocate the joint costs to each product. Finally, subtract the allocated joint costs from the sales revenue of each product to calculate the gross margin of each product.

5 What are the advantages and disadvantages of FIFO method?

The FIFO method has some advantages and disadvantages that you should consider before using it. This method is simple and easy to apply, as it does not require tracking the inventory changes or assigning costs to different batches of production. Moreover, it is consistent with the matching principle, as it matches the costs and revenues of the same period, and avoids the effects of inflation or deflation on the unit costs and gross margins. However, it may overstate or understate the unit costs and gross margins of the joint products, depending on whether there is an increase or decrease in inventory levels. Additionally, FIFO may not reflect the actual physical flow of the joint products, as it ignores the inventory changes. Lastly, this method may not be suitable for industries that have significant fluctuations in inventory levels or prices, as it may distort the profitability analysis of the joint products.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?