FIFO vs LIFO- Differences and Examples

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08 min read.

Inventory valuation is a key accounting function in any manufacturing or trading company. There are three methods of inventory valuation: FIFO (first in, first out), LIFO (last in, first out) and WAC (weighted average cost).

Understanding FIFO

FIFO is a first-in, first-out method of inventory valuation. This inventory valuation method is based on the principle that the products that are first procured should be sold first. It is a simple way of inventory management. Many businesses sell older stocks first as there is a risk of inventory becoming obsolete, and eventually, they may lose value. 

Calculation of Cost of Goods Sold (COGS) under FIFO = Take out the cost of oldest inventory and multiply the same with inventory sold

Industries that use the FIFO method of inventory valuation: 

  • Businesses selling food items
  • Health care products
  • Designer fashions
  • Technology that changes at a faster rate, etc.

Understanding LIFO

LIFO is a last-in, first-out method of inventory valuation. This method is based on the approach that the latest inventory is sold first. It means that the older inventory stays in for a long period. 

Calculation of COGS under LIFO= Take out the cost of your recent inventory and multiply the same with inventory sold.

Industries that use the FIFO method of inventory valuation: Oil and natural gas extraction industry, jewellery etc. 

Let us understand the calculation of the cost of goods sold under both the methods with the help of an example, ABC Ltd. is a retailer selling mobile phones. His inventory cost is as below:


Month

Units

Price

January
100800

February
100815

March
100825

April
100825

400 units were acquired in total.

One can see that the inventory price increased steadily during the quarter. But, the company kept its selling price the same to stay competitive in the market. Suppose the company sold 250 mobile phones during the quarter. Now, let us calculate the cost of goods sold using FIFO and LIFO methods:

FIFO method

100 units at 800= 80,000

100 units at 815= 81,500

50 units at 825= 41,250

Total cost of goods sold= 2,02,750

LIFO method

100 units at 825= 82,500

100 units at 825= 82,500

50 units at 815= 40,750

Total cost of goods sold= 2,06,250

This example shows that the cost of goods sold is higher under the LIFO method. So, we can say that for ABC Ltd. The LIFO method is more suitable as higher cost means lower profits and less payment of taxes. 

Comparison of FIFO and LIFO

Edit
ParticularsFIFOLIFO
ProductsThis method is used for perishable goods or products which soon become obsolete.This method is used for products that are not affected by the time spent in inventory.
TaxationFIFO values the cost of goods sold at a lower price, resulting in higher profits and thus higher taxes.Cost is usually higher under the LIFO method, which results in lower profits and taxes. So, businesses choose to use this to take tax advantage.
Valuation of stockThe stock in hand is valued at more recent prices. Thus, it is more realistic.The stock in hand is valued at old prices.
Valuation of cost of goods soldIt is done at historical prices.It is done at the current price.
StatuteFIFO is allowed by both IFRS and US GAAP.LIFO is allowed only under US GAAP.
AcceptedIt is the most widely accepted method.It is a comparatively less accepted method.