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.
| Aspect |
FIFO |
LIFO |
| Full form |
“First In, First Out” rule. |
Stands for “ Last In, First Out. |
| Definition |
Oldest inventory items are sold or used first. |
Newest inventory items are sold or used first. |
| Cost of Goods Sold (COGS) |
Lower during rising prices as older, cheaper items are sold first. Example: Selling stock bought at INR 4500/unit. |
Higher during rising prices as newer, costlier items are sold first. Example: Selling stock bought at INR 6000/unit. |
| Ideal for |
Ideal for moving perishable products. |
Ideal for storing homogeneous products that do not expire. |
| Ending Inventory Value |
Higher during inflation since newer, costlier items remain in stock. |
Lower during inflation since older, cheaper items remain in stock. |
| Profitability |
Higher during inflation due to lower COGS. |
Lower during inflation due to higher COGS. |
| Tax Implications |
Higher taxes as profits are higher during inflation. |
Lower taxes as profits are lower during inflation. |
| Real-Life Example |
Grocery stores (perishable goods sold in the order they arrive). |
Coal or gravel companies (new material often shipped out first for ease). |
| Accounting Preference |
Widely accepted globally (e.g., under IFRS). |
Allowed in some countries, like the U.S. (under GAAP). |
| Simplicity |
Easier to implement and understand. |
More complex to implement and maintain. |
| Indicator |
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. |
Doesn't provide an accurate or updated inventory value because the valuation is much lower than inventory items at today's prices. |
Read LaterWhat is the FIFO method?
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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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Conclusion: Choosing Between FIFO and LIFO
FIFO and LIFO are different inventory management methods where FIFO prioritizes selling older inventory first, perfect for perishable goods, while LIFO sells the newest inventory first, suiting non-perishable, homogeneous goods like coal, sand, or bricks. It can offer tax advantages in inflationary conditions by lowering taxable profits but might result in outdated inventory valuation.
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.
The choice between these methods depends on the type of products, regulatory compliance, and financial goals. Businesses dealing with fast-moving or perishable goods should favor FIFO, while those managing durable materials might find LIFO more practical. Ultimately, aligning the method with operational and financial strategies ensures adequate inventory and supply chain management.
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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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