Inventory Management Methods: FIFO vs LIFO

The store receives shipments of milk on January 1st at $2 per gallon and on January 10th at $2.50 per gallon. Under FIFO, if the store sells milk on January 12th, it will record the cost of the milk sold at $2 per gallon, assuming it sells the oldest stock first. FIFO is particularly suited to businesses in stable or deflationary markets.

LIFO is not recommended if you have perishable products, since they may expire on the shelf before they are sold or shipped. LIFO also is not an ideal method for businesses expanding globally because a number of international accounting standards do not allow LIFO valuation. FIFO aligns with the natural flow of goods, making it a logical choice for many businesses.

LIFO also results in more complex records and accounting practices because the unsold inventory costs do not leave the accounting system.
On the other hand, on the Balance Sheet, the cost of the inventory still in stock will be taken equal to the cost of the latest inventory added to the stock.
FIFO (First In, First Out) and LIFO (Last In, First Out) are two accounting methods for the value of inventory held by the company.
This might make your financial statements look less attractive.
The leftover goods are accounted for in the remaining inventory.

Key Differences

FIFO and LIFO produce a different cost per unit sold, and the difference impacts both the balance sheet (inventory account) and the income statement (cost of goods sold). Let’s assume that a sporting goods store begins the month of April with 50 baseball gloves in inventory and purchases an additional 200 gloves. Goods available for sale totals 250 gloves, and the gloves are either sold (added to cost of goods sold) or remain in ending inventory. If the retailer sells 120 gloves in April, ending inventory is (250 goods available for sale – 120 cost of goods sold), or 130 gloves. Inventory is often the most significant asset balance on the balance sheet. If you operate a retailer, manufacturer, or wholesale business, inventory may require a large investment, and you need to track the inventory balance carefully.

LIFO Inventory Valuation Method: A Closer Look

For example, a company that sells seafood products would not realistically use their newly-acquired inventory first in selling and shipping their products.
However, this also results in higher tax liabilities and potentially higher future write-offs—in the event that that inventory becomes obsolete.
Every business is different, and good software lets you customize it to fit your needs.
For the sake of simplicity, you purchase plastic two times a year, once during the beginning months and once during the last months.
Ultimately, deciding on inventory valuation is a strategic move in the complex world of corporate finance.

While many nations have adopted IFRS, the United States still operates under the guidelines of generally accepted accounting principles (GAAP). If the United States were to ban LIFO, the country would clear an obstacle to adopting IFRS, thus streamlining accounting for global corporations. FIFO is also more straightforward to use and more difficult to manipulate, making it more popular as a financial tool. FIFO is also the best fit for businesses like food producers or fashion retailers who hold inventory that is perishable or dependent on trends. We’ll use an example to show how FIFO and LIFO produce different inventory valuations for the same business.

The Impact of FIFO vs LIFO on Ending Inventory

FIFO bookkeeping assumes older inventory gets swapped out quickly and regularly, so it’s generally more straightforward to track in your books. Opting for FIFO or LIFO largely depends on your inventory flow, bookkeeping requirements, and tax affairs. FIFO and LIFO are basically opposites of each other, and FIFO is more commonly practiced.

Suppose that a company produces and sells its product in batches of 100 units. If inflation is positive, the cost of production will increase with time. So assume that 1 batch of 100 units is produced within each period, and the cost of production increases after each successive period. An asset management technique, in which the actual issue or sale of goods from the stores is made from the oldest lot on hand is known as First in, first out or FIFO. It follows a chronological order, i.e. it first disposes of the item that is placed in the inventory first. That is why this method of inventory valuation is regarded as the most appropriate and logical one.

Why should you not choose FIFO?

When all inventory items are sold, the total cost of goods sold is the same, regardless of the valuation method you choose in a particular accounting period. In the fast-paced world of retail electronics, picking the right inventory method is key. It helps accurately figure out the cost of sales and affects earnings. For businesses, understanding how their choice affects their finances and taxes is vital. They can choose from FIFO, LIFO, and average cost methods under U.S.

Choosing Between FIFO and LIFO Inventory Valuation

But the downside is that LIFO could make your profits look smaller. On the other hand, FIFO is more likely to show higher profits on paper because it uses the older, cheaper costs. If you manufacture products that can expire, such as food or pharmaceuticals, FIFO might be your best option. That’s because FIFO makes sure you’re selling the oldest items first. In a similar vein, it’s worth mentioning FEFO (First Expired, First Out), which is very similar to FIFO, but specifically works based on expiry dates of goods.

Final Thoughts: Evaluating LIFO and FIFO

For example, the seafood company—from the earlier example—would use their oldest inventory first (or first in) when selling and shipping their products. For example, a company that sells seafood products would not realistically use their newly-acquired inventory first in selling and shipping their products. In other words, the seafood company would never leave their oldest inventory sitting idle since the food could spoil and lead to losses. Another disadvantage of using FIFO is that it typically fails to show an accurate picture of costs when material prices increase rapidly.

This article breaks down LIFO and FIFO, showing how each affects a company’s bottom line. fifo vs lifo Let’s explore these methods and understand their importance in the business world. Accounting for inventory is essential—and proper inventory management helps you increase profits, leverage technology to work more productively, and to reduce the risk of error. It’s important to note that these effects are reversed in periods of falling prices, where LIFO would result in lower COGS and higher inventory values compared to FIFO.

These differences in COGS and profit margins emphasize LIFO’s influence on tax bills. The method often results in lower profits, which could mean paying less in taxes. For those in finance, FIFO helps in making true, deep financial reports. As businesses deal with complex financial reporting, knowing how inventory methods affect real-world business is key.