FIFO: the costing method that changes profit, not what sits in the warehouse

FIFO (from "first in, first out") is the assumption that whatever arrived in the warehouse first is the first to go into cost of sales. Physically, the storekeeper can pick up any box: the method is not about logistics but about which price layer goes into the income statement. For an analyst there is one consequence, and it is an important one: when purchase prices are rising, FIFO sends the oldest, that is the cheapest, batches into cost of sales and leaves the most recent ones on the balance sheet. Profit comes out higher, and the "Inventories" line sits closer to current replacement cost than under any other permitted method.

What exactly happens to the price layers

In the accounts, a warehouse is not a homogeneous mass but a queue of batches, each with its own purchase price. The valuation method determines which end of the queue is drawn on when inventory is expensed. FIFO takes from the front: until the old layer is used up, new prices do not reach cost of sales. Average cost blends the layers into a single figure and responds to price changes smoothly. In Russian accounting there is effectively no third option: LIFO (expensing the latest receipts) was removed from the accounting standard on inventories long ago, and it disappeared from tax accounting from 2015 — it is no longer on the list of methods for valuing raw materials and supplies in paragraph 8 of Article 254 of the Russian Tax Code.

The practical conclusion follows: Russian financial statements and statements under international standards are comparable with each other as far as the costing method goes, but not with those of American companies. There LIFO is permitted and widely used, so their cost of sales is closer to current prices, and their balance-sheet inventories closer to historical ones. Before comparing the margin or inventory value of a Russian processor with an American peer, look in the notes for the disclosed difference between the LIFO valuation and the valuation at current prices — without that adjustment the comparison is meaningless.

Where profit turns into paper profit

The difference between the price of the old layer and the price of replacing it is precisely the profit from holding inventory, not from operations. The company earned it by buying before prices rose. That profit does not repeat in the next round: to keep trading, the inventory will have to be replenished at the new price.

For corpfin tasks this means that in periods of sharply rising commodity prices or a weakening rouble, companies with slow-moving inventory show margins that look better than the business's sustainable earning power. Normalisation here is not cosmetic: you are valuing a stream that has to recur, and a holding gain by definition does not recur. The flip side is symmetrical — when prices reverse, FIFO expenses the expensive layers into cost of sales after selling prices have already fallen, and the margin sinks deeper than the economics of the business.

Sensitivity to the method depends directly on how fast the warehouse moves: inventory turnover shows how long a batch survives before it is expensed. The longer the cycle, the wider the gap between entry and exit prices — and the more the method affects the statements. For a company with fast-moving inventory, the difference between FIFO and average cost is close to immaterial.

What the method does not cancel

FIFO offers no protection against write-downs. Inventories are carried in the statements at the lower of two amounts — cost and net realisable value. If the market has dropped below the purchase price, the expensive layer will have to be impaired whatever the costing method; the impairment itself is charged to the expenses of the period rather than dissolving into the cost of future sales. For importers there is an added exchange-rate layer: the price of a batch is fixed on the date of receipt and is not remeasured after that — here it helps to keep in mind how foreign-currency revaluation works and how the tax logic differs from the accounting logic.

How to read this in the statements

Step 1 — find the method itself in the accounting policy: it is disclosed in the notes, not in the primary statements. Step 2 — compare the movement in the "Inventories" line with the movement in purchase prices: under FIFO the balance sheet reflects recent prices, so growth in inventories in money terms may not mean growth in tonnes or units. Step 3 — check against the physical-volume figures in operating releases, if the company publishes them; the divergence between the monetary and the physical trend is the price effect. The statements and notes are conveniently found in the reports section, and operating data and management commentary in the news feed.

Why this matters in a valuation model

The costing method changes both the numerator and the denominator of the familiar ratios: profit through cost of sales, book value through inventories. That is why the multiples of companies with large inventories are not directly comparable across different phases of the price cycle, and the gap between the market price tag and the estimated value is easily mistaken for cheapness. This distinction is examined in the piece on how price differs from value, and for vertically integrated groups, where one segment sells inventory to another, the sum-of-the-parts valuation approach comes in useful: internal transfers under FIFO shift margin between segments without creating it for the group. Instruments and the sector breakdown are in the list of stocks.