FIFO vs. LIFO | Inventory Valuation Difference + Examples (2024)

Accounting

Step-by-Step Guide to Understanding FIFO vs. LIFO in Inventory Accounting

Last Updated October 30, 2023

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What is FIFO vs. LIFO?

FIFO and LIFO are two methods of accounting for inventory purchases, or more specifically, for estimating the value of inventory sold in a given period.

Table of Contents

FIFO vs. LIFO Accounting: What is the Difference?
FIFO vs. LIFO: What are the Pros and Cons?
How Does LIFO and FIFO Impact Net Income?
FIFO vs. LIFO Calculation Example

FIFO vs. LIFO Accounting: What is the Difference?

FIFO and LIFO are the two most common inventory valuation methods used by public companies, per U.S. GAAP reporting standards.

So, what is the difference between FIFO and LIFO?

FIFO is an abbreviation for “First In, First Out.”

Under the FIFO approach of accounting, the inventory purchased earlier is the first to be recognized and expensed on the income statement, within the cost of goods sold (COGS) line item.
Outside of the U.S., only FIFO is permitted under IFRS, so FIFO tends to be the prevalent inventory valuation method for international companies.

In contrast, LIFO stands for “Last In, First Out.”

LIFO, unlike FIFO, recognizes the more recently purchased inventories ahead of those purchased earlier – i.e. the most recent inventory purchases are the first to be sold.
Under U.S. GAAP accounting standards, the LIFO inventory valuation method is permitted, causing the FIFO vs. LIFO decision to be a discretionary decision for publicly-traded companies.
Hence, many U.S. companies will present their financial statements in accordance with the LIFO method on their filings and financial statements with the SEC, but switch to FIFO for their international operations (e.g. subsidiaries).

FIFO vs. LIFO: What are the Pros and Cons?

The FIFO vs. LIFO accounting decision matters because of the fact that inventory cost recognition directly impacts a company’s current period cost of goods sold (COGS) and net income.

Considering the net income – the accounting measure of profitability (the “bottom line”) on the income statement – is the numerator in the calculation of a company’s earnings per share (EPS) figure, the reported EPS each period is affected too.

The formula to calculate the earnings per share (EPS) metric, on a fully diluted basis, is as follows.

Earnings Per Share (EPS) = Net Income ÷ Total Number of Diluted Shares Outstanding

The following chart describes the implications of the FIFO vs. LIFO decision on a company’s reported net income (and EPS).

Change in Inventory Costs	Inventory Valuation Method	Impact on COGS	Impact on Net Income
Rising Inventory Costs (↑)	FIFO Accounting	Lower COGS	Higher Net Income (and EPS)
Rising Inventory Costs (↑)	LIFO Accounting	Higher COGS	Lower Net Income (and EPS)
Decreasing Inventory Costs (↓)	FIFO Accounting	Higher COGS	Lower Net Income (and EPS)
Decreasing Inventory Costs (↓)	LIFO Accounting	Lower COGS	Higher Net Income (and EPS)

How Does LIFO and FIFO Impact Net Income?

To further expand upon the summary chart, the LIFO vs. FIFO rules under rising inventory costs are as follows:

Rising Inventory Costs ➝ Lower COGS Recorded under FIFO (and Higher Net Income)
Rising Inventory Costs ➝ Higher COGS Recorded under LIFO (and Lower Net Income)

For example, suppose a hypothetical scenario, where the inventory purchased earlier is less expensive compared to recent purchases.

Since the inventory purchased first was recognized, the company’s net income (and earnings per share, or “EPS”) will each be higher in the current period – all else being equal.

With that said, if inventory costs have increased, the COGS for the current period are higher under LIFO.

By contrast, suppose inventory costs were to decline – the impacts of FIFO vs LIFO are as follows:

Declining Inventory Costs ➝ Higher COGS Under FIFO (and Lower Net Income)
Declining Inventory Costs ➝ Lower COGS Under LIFO (and Higher Net Income)

By contrast, the inventory purchased in more recent periods is cheaper than those purchased earlier (i.e. older inventory costs are more expensive).

Therefore, considering the older, more expensive inventory was recognized, net income is lower under FIFO for the given period.

Conversely, COGS would be lower under LIFO – i.e. the cheaper inventory costs were recognized – leading to higher net income.

FIFO vs. LIFO Calculation Example

Suppose a clothing retailer sold 100 units of t-shirts in 2023, at the following pricing rates:

Current Inventory Cost per Unit = $20.00
Past Inventory Cost per Unit = $10.00

The percentage difference in the inventory cost per unit – a 100% increase (i.e. 2.0x) – shows how the retailer’s more recent spending on inventory purchases has increased compared to prior purchases.

% Change in Inventory Cost per Unit = ($20.00 ÷ $10.00) – 1 = 100.00%

Under the two inventory valuation methods, FIFO and LIFO, the following could be recognized as COGS in our simple exercise intended for illustrative purposes:

FIFO → $10.00 × 100 Units = $1,000
LIFO → $20.00 × 100 Units = $2,000

Since inventory costs have risen in recent periods, LIFO causes the retailer’s COGS to increase and net income to decrease on its income statement for the current period – whereas COGS would be lower under FIFO, and the reported net income would be higher.

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FAQs

What is the difference between FIFO and LIFO examples? ›

Key Takeaways. The Last-In, First-Out (LIFO) method assumes that the last unit to arrive in inventory or more recent is sold first. The First-In, First-Out (FIFO) method assumes that the oldest unit of inventory is the sold first.

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Why would a hospital choose to use LIFO rather than FIFO in valuing its inventory? ›

It's easier to value ending inventory using LIFO since you use the most recent costs. That is important if you have a lot of inventory turnover or if prices fluctuate frequently. In periods of inflation, LIFO costing results in a lower cost of goods sold and, therefore, higher net income.

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What is the difference between the FIFO method of inventory valuation and the LIFO method? ›

The first in, first out (FIFO) cost method assumes that the oldest inventory items are sold first, while the last in, first out method (LIFO) states that the newest items are sold first. The inventory valuation method that you choose affects cost of goods sold, sales, and profits.

How to tell if a company uses FIFO or LIFO? ›

FIFO represents First In First Out, where the commodities and services acquired first in the firm are disposed of to the market. In contrast, LIFO represents Last In First Out, where commodities and services acquired lastly in the firm are disposed of first within during sales in the business.

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What is the best example for LIFO? ›

LIFO Example

Here is an example of a business using the LIFO method in its accounting. Brad's Books has sold 450 books to date, each at a price of $25.00. This gives him a total revenue of $11,250 for the last two months. The 450 books are now no longer considered inventory, they are considered cost of goods sold.

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What is FIFO examples and answers? ›

For FIFO, it is based on what arrived first. Assume a company purchased 100 items for $10 each, then purchased 100 more items for $15 each. The company sold 60 items. Under the FIFO method, the COGS for each of the 60 items is $10/unit because the first goods purchased are the first goods sold.

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Why LIFO is not recommended? ›

LIFO understates profits for the purposes of minimizing taxable income, results in outdated and obsolete inventory numbers, and can create opportunities for management to manipulate earnings through a LIFO liquidation. Due to these concerns, LIFO is prohibited under IFRS.

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Why would someone use LIFO instead of FIFO? ›

During times of rising prices, companies may find it beneficial to use LIFO cost accounting over FIFO. Under LIFO, firms can save on taxes as well as better match their revenue to their latest costs when prices are rising.

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What is an example of FIFO in real life? ›

Imagine waiting in line at a store – the person who arrives first gets served before those who come later. This approach ensures fairness and order. It's like arranging books on a shelf – the one you place first is the one you'll pick up first. FIFO is widely used in banks, restaurants, and computer systems.

What is an example of a FIFO problem? ›

For example, a company purchases 100 items at $15 each and later purchases 100 items at $20 each. It sells 75 items. FIFO assumes that those 75 items sold cost the company $15, so the cost of goods sold for that period would be $1,125.

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Why would a company switch to the LIFO method of inventory valuation? ›

Advantages Of Using The LIFO Method

In the U.S., LIFO is sometimes used for tax purposes because of inflation. When prices rise, LIFO gives you the highest cost of goods sold with the lowest taxable income. Valuing your LIFO ending inventory is easier than FIFO because you use your most recent costs.

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What is the main difference between FIFO and LIFO methods of pricing of material issues? ›

Key Takeaways

FIFO and LIFO are accounting methods used to assign value to inventory. FIFO stands for First In, First Out and assumes older products are sold first. LIFO stands for Last In, First Out and assumes that the most recently purchased products are sold first.

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How to calculate FIFO and LIFO examples? ›

To calculate FIFO (First-In, First Out) determine the cost of your oldest inventory and multiply that cost by the amount of inventory sold, whereas to calculate LIFO (Last-in, First-Out) determine the cost of your most recent inventory and multiply it by the amount of inventory sold.

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Is FIFO or LIFO better for small business? ›

Most companies prefer FIFO to LIFO because there is no valid reason for using recent inventory first, while leaving older inventory to become outdated. This is particularly true if you're selling perishable items or items that can quickly become obsolete.

Does FIFO or LIFO do a better job of matching expenses and revenues? ›

FIFO tends to reflect current market prices better. LIFO better matches current costs with revenue and provides a hedge against inflation. Choosing among weighted average cost, FIFO, or LIFO can have a significant impact on a business' balance sheet and income statement.

What is an example of LIFO food? ›

Last In, First Out (LIFO)

An example of this is when a restaurant stocks up on canned food but continues to purchase fresh ingredients. Rather than using the older canned goods, the staff use newer inventory instead.

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What is LIFO and FIFO in data structure with example? ›

LIFO, which stands for 'last in, first out,' is defined as a data structure in which the newest element added to the stack is processed first. On the other hand, FIFO, which stands for 'first in, first out,' is defined as a data structure wherein the first element added to the queue is processed first.