Difference Between FIFO and LIFO
FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) are two distinct inventory management methods that dictate how goods are sold and valued within a business. The choice between these methods can significantly impact a company's financial statements, tax liabilities, and overall inventory valuation. Read about the difference between FIFO and LIFO systems and learn which system should you choose for an effective supply chain management.
The FIFO and LIFO systems are accounting methods designed to value established inventories based on a company’s economic policy. It encompasses the value of the products that the company associates with an inventory of produced goods, raw materials, or components. When we refer to industrial warehousing operations, the FIFO and LIFO systems have to do with how goods move through the warehouse. Nevertheless; these two systems are completely different. This article explores the main difference between FIFO and LIFO systems.
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Comparison Table – FIFO vs LIFO
The FIFO method assumes that the oldest inventory unit is sold first, while the LIFO method assumes that the last unit to arrive in inventory or more recent is sold first.
| FIFO | LIFO |
| Based on the “first in, first out” rule. | Stands for “ Last In, First Out. |
| This method is based on the understanding that the next item sold is the one that will have been stored the longest. | A method of recording the value of an inventory by which it is assumed that the last goods bought will be sold first. |
| The company moves the products that are closest to their expiration date. | The company does not replace sold inventory or seek to increase its profit; old inventory is sold or liquidated. |
| Ideal for moving perishable products. | Ideal for storing homogeneous products that do not expire. |
| FIFO is a better indicator of the value for ending inventory since older items have been used up while the newest items reflect current market prices. | It doesn’t provide an accurate or updated inventory value because the valuation is much lower than inventory items at today’s prices. |
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What is the FIFO method?
FIFO is the abbreviation for “First In, First Out”. That means the one that comes first will be the first out. This method is an essential component in warehouse management. This method prioritizes the oldest goods when it comes to dispatching.
With the FIFO method, the first batch of merchandise that enters the warehouse must be the first to leave. The output of products that have been stored the longest is prioritized.
Mainly for perishable products with an expiration date. Due to the nature of these products, removing what first enters the store is necessary. Otherwise, we may risk losing the lot closest to expiration due to incorrect management.
The FIFO method ensures good stock rotation. It is the best solution for storing perishable products with a short life cycle and requiring perfect stock rotation. Mainly food or medicines, in which the expiration date is important. This also includes fashion items that are usually season or trend-based or technology items that come with updated versions every other day.
What is the LIFO method?
The acronym LIFO stands for “Last In, First Out”. That is, last in, first out. Here the system is piles or stacking. This means that stored products go in and out of the same place.
In the LIFO method, the last batch that enters the warehouse must be the first to leave. Here the last batches manufactured or purchased are the first to leave our warehouse. The newest one has priority in leaving with respect to the others.
This method can be used to store products that do not have short expiration dates. When stock rotation is not a determining factor, storage systems designed in LIFO mode can be used. With good general warehouse management, the product leaves in full condition without expiring or deteriorating.
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When to Use the FIFO or LIFO methods?
It is necessary to know when to use these merchandise management methods. The FIFO method should always be used when the first merchandise that enters the warehouse is the first to leave.
This is essential in all stores of perishable products, such as food, medicines or cosmetics. It applies to products that go out of style, such as clothing, or obsolete, such as technology products. This method applies to both warehouses and supermarkets.
In the LIFO method, ensure that the last entry to the warehouse will be the first to leave. This helps to prioritize the new merchandise. This system is ideal for storing homogeneous products that do not expire or perish. It applies to sand, bricks, coal or stone since they do not change over time. It does not matter how long they are stored; since they do not, they will produce losses due to expiration, obsolescence, etc.
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FAQs
Which inventory costing method is more aligned with matching expenses with revenues?
FIFO is more aligned with the matching principle, as it matches older, lower-cost inventory with current revenues, leading to a more accurate representation of the cost of goods sold.
Are there any regulatory considerations when choosing between FIFO and LIFO?
Yes, some countries or accounting standards may have specific regulations regarding using FIFO or LIFO. For example, the United States generally accepts using both methods, but the Internal Revenue Service (IRS) requires specific rules to be followed for LIFO.
Is one inventory costing method inherently better than the other?
There is no one-size-fits-all answer. The choice between FIFO and LIFO depends on the company's specific needs, tax strategies, and the nature of its inventory and sales.
Can a company switch between FIFO and LIFO at its discretion?
Companies usually consistently stick to one inventory costing method to maintain consistency in financial reporting. Switching between methods may require justification and may have tax implications.
How do FIFO and LIFO impact inventory valuation on the balance sheet?
FIFO generally results in a higher ending inventory valuation on the balance sheet during inflation, as the older, lower-cost inventory remains in stock. On the other hand, LIFO leads to a lower ending inventory valuation due to using higher-cost, more recent purchases in the cost of goods sold calculation.
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