Gross profit is calculated by subtracting the cost of goods sold (COGS) from total revenue. When using the FIFO (First In, First Out) inventory valuation method, the cost of goods sold is calculated based on the cost of the oldest inventory items first. Here are the steps to compute gross profit using FIFO:
Steps to Calculate Gross Profit using FIFO:
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Determine Total Revenue:
- Calculate the total sales revenue from all the goods sold during the period. \[ \text{Total Revenue} = \text{Selling Price} \times \text{Quantity Sold} \]
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Determine Cost of Goods Sold (COGS) using FIFO:
- Using FIFO, list out your inventory purchases in chronological order based on their purchase date and price.
- For each sale, start subtracting from the oldest inventory first until you've accounted for all the units sold. Add up the costs of the inventory items that were sold to determine the COGS.
Example: Let's say a company has the following inventory purchases:
- 100 units at $10 each (Purchased on Jan 1)
- 150 units at $12 each (Purchased on Feb 1)
- 200 units at $15 each (Purchased on Mar 1)
If the company sells 250 units:
- The first 100 units are taken from the Jan 1 inventory: 100 x $10 = $1,000
- The next 150 units are taken from the Feb 1 inventory: 150 x $12 = $1,800
- Total COGS = $1,000 + $1,800 = $2,800
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Calculate Gross Profit: \[ \text{Gross Profit} = \text{Total Revenue} - \text{COGS} \]
Continuing the Example: If the selling price is $20 per unit, and the company sold 250 units: \[ \text{Total Revenue} = 250 \times 20 = 5,000 \] \[ \text{Gross Profit} = 5,000 - 2,800 = 2,200 \]
Summary:
- Total Revenue: Amount earned from sales.
- COGS using FIFO: Cost associated with the oldest units sold first.
- Gross Profit: Difference between total revenue and COGS.
By following these steps, you can accurately compute gross profit using the FIFO inventory method.