May 2024

Under LIFO, the remaining inventory value is lower, since the older and cheaper goods are left in the warehouse and only sold after the new products. Under FIFO, older (and therefore usually cheaper) goods are sold first, leading to a lower average cost of goods sold. FIFO and LIFO also have different impacts on inventory value and financial statements. Organizations using advanced inventory management systems can effectively handle LIFO’s complexities. Despite its complexity, LIFO provides valuable cost matching and profit management advantages. This method mainly benefits companies operating in inflationary markets or those dealing with commodities. The most glaring issue of LIFO is that it requires businesses to hold onto their oldest product units for extended periods. The same reason that it’s disallowed under the IFRS is the same reason businesses use it. It requires businesses to collect more data and maintain highly accurate records. Keeping track of all incoming and outgoing inventory costs is key to accurate inventory valuation. LIFO assumes the newest inventory items are sold first, resulting in higher COGS and lower net income, which can reduce taxable income. FIFO may be preferable for businesses seeking to maintain an accurate reflection of current inventory costs and higher profitability during inflation. What is inventory revaluation, and how does it help your business? A business managing perishables would never use LIFO because product aging would become unmanageable. FEFO is more precise for regulated items, while FIFO is simpler and works best for general retail. From a warehouse standpoint, FIFO almost always wins, unless the goal is purely tax-based. FIFO and LIFO differ in both operational flow and financial impact. If you’re wondering how to apply it, research how to calculate FIFO and LIFO for tax purposes rather than for warehouse movement. Differences between FIFO and LIFO With FIFO—first in, first out—the oldest inventory is sold first, making it ideal for businesses where goods need to be rotated regularly, such as in food or retail. Regardless of which method a company matching principle definition uses, poor inventory tracking leads to stock shortages, excess parts sitting unused, and maintenance teams scrambling for replacements when equipment fails. FIFO is generally easier to implement, aligns with the natural flow of inventory, and ensures financial statements accurately reflect true inventory costs. To know which method is best suited for your business, you need to look at the way your inventory costs are changing. The IASB standards prohibit the use of LIFO as an inventory valuation method. It’s useful for retail companies that need to stay on top of trends and quickly sell fashionable items. UK companies must use FIFO inventory accounting in alignment with International Financial Reporting Standards (IFRS). FIFO aligns with natural inventory flow and is widely accepted globally, while LIFO provides tax benefits during inflation but has limited applicability. LIFO typically provides better tax advantages during inflation by matching current costs with current revenues. Kristen Slavin is a CPA with 16 years automatic data processing of experience, specializing in accounting, bookkeeping, and tax services for small businesses. FreshBooks accounting software lets you organize inventory costs, keep track of shipments, and organize invoices so you can stay on top of vendor payments. The right accounting software helps you track your inventory values so you can quickly and easily calculate costs. We’ll use an example to show how FIFO and LIFO produce different inventory valuations for the same business. Gross income is calculated by subtracting the cost of goods sold from a company’s revenue for a given period. More Complex Inventory Tracking and Management LIFO, however, values inventory at older, lower costs, which can make your balance sheet look weaker. These layers make it hard to report price changes, as altering one can affect the cost of items sold. Using FIFO, the cost of goods usually stays stable, making it easy to track inventory and costs. FIFO calculates cost of goods sold (COGS) based on older, lower-cost inventory, while LIFO uses the most recent, higher-cost inventory for COGS calculations. Below, see how each method is applied to the same inventory purchases and sales, leading to different financial outcomes. Since older, lower-cost inventory remains on the books, it can make your financial statements look weaker. While various inventory valuation methods such as Last-In-First-Out (LIFO), First-In-First-Out (FIFO) and Weighted-Average-Cost (WAC) are available, it is advisable to use the right method based on business activities as using the wrong valuation method can greatly affect a business. Learn more about what FIFO is and how it’s used to decide which inventory valuation methods are the right fit for your business. The FIFO method, or First In, First Out method, is an inventory valuation approach where the oldest inventory items are sold first. To determine this cost, the value (cost) of inventory that is sold during the year must be calculated by some reasonable method that is common to all businesses. Using the FIFO inventory method, this would give you your Cost of Goods Sold for those 15 units. Using FIFO does not necessarily mean that all the oldest inventory has been sold first—rather, it’s used as an assumption for calculation purposes. We want to help you achieve an efficient and cost-effective fulfillment solution for your business. Understanding FIFO, LIFO, and FEFO, and knowing which one fits your business, is essential. It’s important to consider that LIFO is not permitted under International Financial Reporting Standards (IFRS), limiting its use for companies operating internationally. FIFO and LIFO significantly affect financial statements differently. The choice between FIFO and LIFO can have significant tax implications. The choice between FIFO vs LIFO affects various aspects of financial statements. Tractian’s CMMS eliminates the guesswork by providing real-time visibility into stock levels, part usage, and reorder points. This difference of influence between FIFO and LIFO is why aligning your maintenance strategy with your inventory is so important. The choice between FIFO or LIFO influences everything from how spare parts are used to how financial resources are allocated for repairs and replacements. 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