First in, first out accounting refers to the inventory management practice in which a small business sells or uses the inventory that is bought or produced first.
Assume you have a small business that sells lamps. In your inventory, you have a lamp that you bought six months ago for $10 and an identical lamp that you bought a day ago for $15. When a customer buys a lamp from you for $20, FIFO accounting assumes the customer is buying the lamp you bought six months ago. Your gross margin of selling the lamp is $20 – $10 = $10.
One disadvantage of FIFO accounting is it often leads to overstated gross margin during inflation when the cost of the older inventory tends to be lower than the cost of the newer inventory.