FIFO vs.

LIFO accounting July 29, 2017

FIFO and LIFO are cost layering methods used to value the cost of goods sold and ending
inventory. FIFO is a contraction of the term "first in, first out," and means that the goods first
added to inventory are assumed to be the first goods removed from inventory for sale. LIFO is a
contraction of the term "last in, first out," and means that the goods last added to inventory are
assumed to be the first goods removed from inventory for sale.

Why use one method over the other? Here are some considerations that take into account the
fields of accounting, materials flow, and financial analysis:

Issue FIFO Method LIFO Method

 In most businesses, the actual flow There are few businesses where the
Materials flow of materials follows FIFO, which oldest items are kept in stock whiler
makes this a logical choice. newer items are sold first.
If costs are increasing, the first items If costs are increasing, the last items
sold are the least expensive, so your sold are the most expensive, so your
cost of goods sold decreases, you cost of goods sold increases, you report
Inflation
report more profits, and therefore pay fewer profits, and therefore pay a
a larger amount of income taxes in smaller amount of income taxes in the
the near term. near term.
If costs are decreasing, the first items If costs are decreasing, the last items
sold are the most expensive, so your sold are the least expensive, so your
cost of goods sold increases, you cost of goods sold decreases, you
Deflation
report fewer profits, and therefore report more profits, and therefore pay a
pay a smaller amount of income larger amount of income taxes in the
taxes in the near term. near term.
IFRS does not all the use of the LIFO
There are no GAAP or IFRS method at all. The IRS allows the use
Financial
restrictions on the use of FIFO in of LIFO, but if you use it for any
reporting
reporting financial results. subsidiary, you must also use it for all
parts of the reporting entity.
There are usually more inventory
There are usually fewer inventory
layers to track in a LIFO system, since
Record layers to track in a FIFO system,
the oldest layers can potentially remain
keeping since the oldest layers are continually
in the system for years. This increases
used up. This reduces record keeping.
record keeping.
Reporting Since there are few inventory layers, There may be many inventory layers,
fluctuations and those layers reflect recent some with costs from a number of
pricing, there are rarely any unusual years ago. If one of these layers is
spikes or drops in the cost of goods accessed, it can result in a dramatic
 sold that are caused by accessing old increase or decrease in the reported
inventory layers. amount of cost of goods sold.

In general, LIFO accounting is not recommended, for the following reasons:

 It is not allowed under IFRS, and a large part of the world uses the IFRS framework.
 The number of layers to track can be substantially larger than would be the case under
FIFO.
 If old layers are accessed, costs may be charged to expense that vary substantially from
current costs. 

In essence, the primary reason for using LIFO is to defer the payment of income taxes in an
inflationary environment.