Process costing is used in industries where production flows continuously — think paint factories, cement plants, or a dal mill. When units are partially done at the start of a period (called Opening WIP — Work-in-Progress), you need a method to handle their costs fairly. That's where FIFO (First-In, First-Out) comes in: it assumes you finish the old batch first, before starting fresh units.
Here's the core idea: under FIFO, you keep opening WIP costs separate from current period costs. You only use current period costs to calculate the cost per equivalent unit. This is the biggest difference from the Weighted Average Method, where you pool opening WIP costs with current costs. FIFO is more precise — it tells you exactly what it cost this period to produce.
The calculation has four steps. Step 1 — work out Equivalent Units (EU) using the FIFO formula: EU = (Opening WIP units × % work still to be done) + Units started and fully completed this period + (Closing WIP units × % work done). Step 2 — calculate Cost Per Equivalent Unit = Current period costs ÷ Total EU (do NOT add opening WIP costs here). Step 3 — assign costs to completed units: Opening WIP gets its brought-forward cost plus the cost to complete the remaining work; freshly started-and-completed units get the full current cost per EU. Step 4 — value Closing WIP at cost per EU × closing WIP equivalent units.
Why does FIFO matter for exams? The ICAI frequently tests it as a 10–12 mark problem in Paper 4, especially with two or three cost elements (materials, labour, overheads) each at different completion percentages. The examiner loves to give you opening WIP at 40% complete and closing WIP at 60%, forcing you to carefully compute EU for each cost element separately. Always make a neat statement of equivalent units — examiners award step marks.