Business Glossary

price of buying or making an item that is sold; also calledcost of goods sold. The difference between sales and cost of sales is gross profit. For a retail business, the cost of sale is the purchase price of the item. For a manufactured good, the cost of sale includesdirect material, direct laborand factory overheadassociated with producing it. An example would be the cost to General Motors of making a car. An illustrative example of a gross profit calculation for a retail business follows:

method of accounting for inventory that ties the cost of goods sold to the cost of the most recent purchases. The formula for cost of goods sold is:
beginning inventory + purchases – ending inventory = cost of goods sold

In contrast to the first in, first out (FIFO) method, in a period of rising prices LIFO produces a higher cost of goods sold and a lower gross profit and taxable income. The artificially low balance sheet inventories resulting from the use of LIFO in periods of inflation give rise to the term LIFO cushion.

portion of overhead costs-rent, lights, insurance -allocated to manufacturing, by the application of a standard factor termed a burden rate. This amount is absorbed as an inventory cost and ultimately reflected as a cost of goods sold.

method of accounting for inventory whereby, quite literally, the inventory is assumed to be sold in the chronological order in which it was purchased. For example, the following formula is used in computing the cost of goods sold:

Under the FIFO method, inventory costs flow from the oldest purchases forward, with beginning inventory as the starting point and ending inventory representing the most recent purchases. The FIFO method contrasts with the LIFO or Last In First Out (LIFO) method, which is FIFO in reverse. The significance of the difference becomes apparent when inflation or deflation affects inventory prices. In an inflationary period, the FIFO method produces a higher ending inventory, a lower cost of goods sold figure, and a higher gross profit. LIFO, on the other hand, produces a lower ending inventory, a higher cost of goods sold figure, and a lower reported profit.

In accounting for the purchase and sale of securities for tax purposes, FIFO is assumed by the IRS unless it is advised of the use of an alternative method.