FIFO vs LIFO: Comparing Inventory Valuation Methods

When prices are rising, FIFO results in lower COGS because older, cheaper inventory is used for calculations. In real-world operations, companies often make multiple inventory purchases over time, requiring more complex calculations under LIFO and FIFO. Although the ABC Company example above is fairly straightforward, the subject of inventory—and whether to use LIFO or FIFO—can be complex. Knowing how to manage inventory is critical for all companies, no matter their size. It is also a major success factor for any business that holds inventory because it helps a company control and forecast its earnings. For investors, inventory is an important item to analyze because it can provide insight into what’s happening with a company’s core business.

Can Lead to Overstated Profits

LIFO usually doesn’t match the physical movement of inventory because companies are more likely to try to move older inventory first. However, car dealerships or oil companies may try to sell items marked with the highest cost to reduce their taxable income. In the tables below, we use the inventory of a fictitious beverage producer, ABC Bottling Company, to see how the valuation methods can affect the outcome of a company’s financial analysis. Assuming that prices are rising, this means that inventory levels are going to be highest because the most recent goods (often the most expensive) are being kept in inventory.

( . FIFO perpetual inventory card:

The International Financial Reporting Standards, or IFRS, however, only accepts FIFO of the two. Excel is a powerful tool for Excel inventory management; it helps to track stock levels, optimize costs, and ensure efficient operations. FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) are two commonly used inventory valuation methods. In this article, we will show FIFO/LIFO analysis by using a structured dataset. FIFO frequently results in higher reported profits, whereas LIFO can decrease retained earnings balance sheet taxable income during periods of rising costs.

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However, if inventory remains stagnant for a few years, there can be a significant discrepancy between cost of goods sold and market value when sales resume. The rate of inflation impacts the size of the tax differential created by FIFO and LIFO. Under a high-inflation economy, using how to do fifo and lifo FIFO results in a significantly lower COGS, leading to a higher taxable income and tax bill.

LIFO and FIFO: Advantages and Disadvantages

This reduces gross profit and net income, which might seem less attractive to investors. However, the lower net income can be advantageous for tax purposes, as it reduces the taxable income. On the balance sheet, LIFO often results in lower inventory values, https://www.bookstime.com/ which can make the company appear less asset-rich.