What Is the Difference Between FIFO and LIFO?
FIFO (first in, first out) and LIFO (last in, first out) are two inventory cost flow methods. They decide which unit costs go to cost of goods sold and which stay in ending inventory when purchase prices change. FIFO assumes the oldest units are sold first. LIFO assumes the newest units are sold first. The physical movement of goods does not have to match the assumption.
FIFO vs. LIFO Example
EXAMPLE
A company buys 100 units at $10, then 100 at $12, then 100 at $14, and sells 150 units. Total purchases are $3,600.
- FIFO:
COGS = 100 x $10 + 50 x $12 = $1,600. Ending inventory = 50 x $12 + 100 x $14 = $2,000. - LIFO:
COGS = 100 x $14 + 50 x $12 = $2,000. Ending inventory = 100 x $10 + 50 x $12 = $1,600.
Both methods account for the same $3,600 of purchases. They only split it differently between the income statement and the balance sheet.
Weighted Average Cost, the Third Method
Weighted average cost assigns the average cost of all units available to both cost of goods sold and ending inventory. In the example the average is $3,600 / 300 = $12 per unit, so COGS is 150 x $12 = $1,800 and ending inventory is $1,800. Weighted average smooths price changes and lands between FIFO and LIFO.
How FIFO and LIFO Affect Profit and Taxes
- FIFO when prices rise:
Lower cost of goods sold, higher profit, higher taxes, and higher inventory value. - LIFO when prices rise:
Higher cost of goods sold, lower profit, lower taxes, and lower inventory value. - When prices fall:
The effects reverse.
The method also changes gross margin and inventory turnover figures, described in cost of goods sold.
LIFO Liquidation and Periodic vs. Perpetual Systems
Two details trip people up when they move from textbook examples to real systems.
- LIFO liquidation:
If a company sells more than it buys in a period, it dips into old, low-cost layers. Those costs flow into cost of goods sold, profit jumps, and the tax bill rises. The gain is temporary and reflects old prices, not better performance. - Periodic vs. perpetual:
FIFO gives the same result under both systems. LIFO does not. A LIFO calculation done at period end can differ from one that updates with every sale, so check which your system uses.
COMMON MISTAKE
Assuming the method follows the physical movement of goods. FIFO and LIFO are cost flow assumptions. A warehouse can ship its oldest stock first and still use LIFO for accounting, where the rules allow it.
GAAP, IFRS, and Tax Rules
- US GAAP:
Allows both FIFO and LIFO. - IFRS:
Does not allow LIFO. FIFO and weighted average cost are permitted. - US tax:
A company that uses LIFO for tax must also use it for financial reporting, a rule known as LIFO conformity. - LIFO reserve:
Companies using LIFO usually disclose the difference between LIFO and FIFO inventory values.
Choosing a Method
- Perishable or dated goods:
FIFO matches physical flow and avoids obsolete stock. - Rising costs and tax deferral:
LIFO may lower taxable income where it is permitted. - Global reporting:
FIFO or weighted average, since IFRS does not allow LIFO. - Systems accuracy:
Whichever method is chosen, receipts and invoices must post accurately or the cost layers drift, described in landed cost.
Inventory carried below cost is also tested at each reporting date, described in lower of cost or net realizable value.
Frequently Asked Questions About FIFO vs. LIFO
1. What are FIFO and LIFO used for?
Both are rules for deciding which purchase costs leave inventory first when you sell goods. FIFO uses the oldest costs first, LIFO the newest. When prices move, that choice changes cost of goods sold, taxable profit, and the value left on the balance sheet.
2. Which method gives higher profit when prices are rising?
FIFO. When prices rise, FIFO charges older, lower costs to cost of goods sold, so reported profit is higher and ending inventory is valued higher. LIFO does the opposite, reporting lower profit and lower taxable income.
3. Is LIFO allowed under IFRS?
No. IFRS prohibits LIFO and permits FIFO and weighted average cost. US GAAP allows LIFO, and US tax rules require a company that uses LIFO for tax to use it in its financial statements too.
4. What is the difference between FIFO, LIFO, and weighted average?
Weighted average assigns the average cost of all units available to both cost of goods sold and ending inventory. FIFO uses the oldest costs first, and LIFO uses the newest first. Weighted average results fall between FIFO and LIFO.
5. What is an example of FIFO vs. LIFO?
A company buys 100 units at $10, 100 at $12, and 100 at $14, then sells 150. FIFO cost of goods sold is $1,600. LIFO cost of goods sold is $2,000. Both leave different ending inventory but total purchases of $3,600.
