What are FIFO and LIFO?

The FIFO and LIFO methods are accounting techniques that are used o manage inventory and financial matters involving the amount of money a company spent within inventory of produced goods, raw materials, parts, components or feed stocks. These methods are used to manage any assumptions on the cost flows related to inventory, repurchases and other accounting purposes.

FIFO

FIFO stands for first-in, first-out. This means that the oldest stock is recorded as the first sold. This does not necessarily mean that the exact oldest stock has been tracked and sold. The cost that’s associated with the inventory that was purchased first, was the first cost expense. With the FIFO method, the cost of inventory that’s reported on the balance sheet, will represent the cost of inventory that was most recently purchased.

The FIFO method can be used is both the periodic inventory system and the perpetual inventory system.

LIFO

LIFO is just the opposite of FIFO. It stands for first-in, last-out. This means that the most recently produced items are recorded as being the first sold. This method is mostly used in the US. In the 1970’s, some US companies shifted towards the use of LIFO. This reduced their income taxes in times of inflation. The International Financial Reporting Standards have banned the use of LIFO and more companies have reverted to FIFO.

The LIFO method is used differently in the periodic inventory system and the perpetual inventory system.

Difference between FIFO and LIFO.

The difference between the cost of inventory calculated under the FIFO and LIFO method is called the LIFO reserve. This reserve is essentially the amount by which an entity’s taxable income has been deferred by using the LIFO method.

FIFO

LIFO

Stand for First in, first out Last in, first out
Unsold inventory Compromised of goods acquired most recently Comprised of the earliest acquired good
Restriction There are no GAAP or IFRS restrictions IFRS does not allow the use of LIFO
Effect of Inflation The cost of goods sold under FIFO is cheaper and so profit increases. The income tax is larger. The value of any unsold inventory is higher. The cost of goods sold (COGS) under LIFO increases and the net profit decreases. The income tax and the value of any unsold inventory is lower.
Effect of Deflation The accounting profit and income tax is lower using FIFO in a deflationary period. The value of unsold inventory is also lower. When LIFO is used, both the accounting profit and value of any unsold inventory is higher.
Record keeping The number of records that must be maintained decreases as the oldest items ares old first. The number of records that have to be maintained, increases since the newest items are sold first and the oldest items might remain in the inventory for a long period of time.
Fluctuations There is no unusual increase or decrease in the cost of goods sold because the newest items remain in the inventory. That means that the costs are more recent. Unusual increases or decreases in cost of goods may take place due to selling goods that have been in the inventory for a period of months or years.