QuickBooks uses average cost to compute the cost of inventory items. This determines the expense that is created when these items are sold.
With Advanced Inventory, there is an option for FIFO (first in first out) costing. QuickBooks implements this by using cost lots.
If 10 widgets are purchased at $20.00 each, that becomes cost lot 1.
If another 10 are purchased at $22.00 each, that becomes cost lot 2.
Another purchase of 10 at $25.00 each becomes yet another cost lot, #3.
Assume then an invoice is created selling 5 of the widgets. The cost of those is recorded in QuickBooks as $100 (5 X 20).
Assume another invoice is created for 10 widgets. The cost of those will be $210. 5 from cost lot 1 at $20 each plus another 5 from cost lot 2 at $22 each.
This happens in the background and is not controlled by the QuickBooks user once the setting to use FIFO is selected. There is one report to track cost lots. Reports->Inventory->FIFO Cost Lot History by Item.
The setting is chosen in the preferences for Advanced Inventory.
The cautions with using FIFO costing are as follows:
- When the selection is made, QuickBooks asks for a date as the starting point for using this feature. As of that date, all existing quantities of an item are used to create the first cost lot at the then existing average cost. This date is usually set as the beginning of the current fiscal year. An earlier date will cause a recalculation of inventory transactions in that time period and change year-end accounting numbers for the previous year(s).
- When implementing this on a large file, leave plenty of time for the system to work through the changes. It must be done in single-user mode and on very large files, could take hours.
- If you later edit a bill or item receipt from before the starting date, this will change the beginning cost calculations and changes will ripple through the entire system, catching all existing transactions up to the new calculated cost.
- You can change and go back to average cost. But if you do, all transactions in the company file will revert to average cost, again, almost surely altering the financial reports for past years.
Hector Garcia, CPA
Certified Advanced QuickBooks ProAdvisor