LIFO Vs FIFO: Key DIfferences & Applications (Guide) (2024)

Today we’ll be discussing the differences between LIFO (last-in, first-out) and FIFO (first-in, first-out). Each of these are specific inventory management styles that allow warehouses to prioritize what they will sell and when.

In some cases, these inventory styles will fit specific industries better than others. We’ll break down each of them so that you can have a good idea of what works best for your industry and how to implement the system well.

LIFO—Last-In, First-Out

The LIFO method uses the practice of taking the items that were last received into your warehouse and selling them or shipping them first. So, selling or shipping the newest, most recent items first.

Pros of LIFO

A higher cost of goods sold, lower profits, less tax liability with inflation.
During deflation, lower cost of goods sold, higher profits, and higher tax liability.
More profits and more appealing to investors during deflation.

Cons of LIFO

More complex to understand.
Older inventory items may cause costs of goods sold to fluctuate when sold at a later date.
Not compatible with the IFRS (International Financial Reporting Standards) accounting method.
Lower earnings which can discourage investors.

As you can see, there are quite a few variables that determine whether your warehouse will see success using the LIFO to manage inventory within the warehouse. Making a good profit by selling the most recent stock first, will primarily depend on whether the economy is in a time of inflation or deflation. During deflation, LIFO can make your warehouse extremely profitable, but you could potentially lose money during inflation. LIFO is by far a much more significant risk to your bottom line.

FIFO—First-In, First-Out

The FIFO method is opposite to LIFO in that, the items that have been in your warehouse the longest would be sold first. This is a standard method at grocery stores and other similar suppliers where products will deteriorate or expire with age. It could be summed up as selling or shipping the oldest items first before any newer items.

Pros of FIFO

Compatible with both IFRS (International Financial Reporting Standards) and GAAP (Generally Accepted Accounting Principles).
Low complexity and easy to understand.
Minimal to no fluctuation in COGS.
During inflation—lower cost of goods sold, higher profits, greater tax liability, and higher earnings with more appeal to investors.

Cons of FIFO

During deflation—higher cost of goods sold, lower profits, less tax liability, and lower earnings with less appeal to investors.

The FIFO method will help you to maximize profits on your inventory without having to risk as many variables. As you’d probably guess, based on the pros and cons, FIFO makes sense for many more business models and is seen to be more of an industry standard. Additionally, if you ever expand your business internationally, FIFO is more broadly accepted as a way to determine net income.

How to Calculate COGS with Each Method

Calculating COGS is critical to having a successful business. To help you have a better understanding of how these different methods work, here are examples of how to calculate the costs of goods sold.

LIFO –to calculate COGS with the LIFO method, determine the cost of your most recent inventory and multiply that by the amount of inventory sold.

FIFO –to calculate COGS with the FIFO method, determine the cost of your oldest inventory and multiply that by the amount of inventory sold.

After you have those numbers, there are just two steps left. First, account for price fluctuations to develop an average. And secondly, be sure to remove any inventory that hasn’t yet been sold. You can’t account for inventory that hasn’t been sold.

LIFO vs FIFO

So, the question remains, which system is a better accounting method? The answer, unfortunately, isn’t simply one or the other. It really depends. If you’re new to the industry, we’d strongly suggest that you do some more research on the topic and encourage you to start with the more simple, FIFO. But, more experienced business owners and operators might take the calculated risk of trying the LIFO method. While LIFO does propose more risk out of the two accounting methods, a company that uses it on the right product at the right time can do really well.

Industries That Use LIFO

Here are some of the industries that often use the LIFO method:

Automotive industries when needing to quickly ship.
Petroleum-based production companies.
Pharmaceutical industries with some products.

Industries That Use FIFO

Here are the industries that often use the FIFO method:

Grocery Stores
When inventory is perishable or expires.
Companies that need to make sure they don’t have old inventory.

Ultimately both of these accounting methods will work better when paired with top-notch inventory management software. A system likeExtensiv Warehouse Managerfrom Extensiv Warehouse Manager will help you keep track of inventory as it comes in the door and, in turn, accurately pick, pack, and ship. To learn more about topShelf,reach out to Extensiv Warehouse Manager today!

FAQs

LIFO Vs FIFO: Key DIfferences & Applications (Guide)? ›

Key Takeaways

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What are the key differences between LIFO and FIFO? ›

Key Takeaways

The Last-In, First-Out (LIFO) method assumes that the last unit to arrive in inventory or more recent is sold first. The First-In, First-Out (FIFO) method assumes that the oldest unit of inventory is the sold first.

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What are the applications of LIFO and FIFO? ›

LIFO, on the other hand, is when you first sell the newer products in your inventory while older products remain on warehouse shelves. FIFO is the standard method modern manufacturing companies use, especially ones that manage perishable goods. Companies use FIFO and LIFO to calculate the cost of goods sold (COGS).

What is FIFO and LIFO for dummies? ›

The first in, first out (FIFO) cost method assumes that the oldest inventory items are sold first, while the last in, first out method (LIFO) states that the newest items are sold first. The inventory valuation method that you choose affects cost of goods sold, sales, and profits.

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How to tell if a company uses FIFO or LIFO? ›

Under LIFO, a business records its newest products and inventory as the first items sold. The opposite method is FIFO, where the oldest inventory is recorded as the first sold. While the business may not be literally selling the newest or oldest inventory, it uses this assumption for cost accounting purposes.

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What are the advantages and disadvantages of FIFO and LIFO? ›

After looking at the FIFO and LIFO difference, both methods have pros and cons. FIFO focuses on using up old stock first, whilst LIFO uses the newest stock available. LIFO helps keep tax payments down, but FIFO is much less complicated and easier to work with.

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When comparing the FIFO and LIFO inventory methods? ›

FIFO results in higher ending inventory values and higher net income. This increases taxable income and taxes owed. LIFO results in lower ending inventory on the books and lower net income. This reduces taxable income and income tax expenses.

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What is a real life application of FIFO? ›

Imagine waiting in line at a store – the person who arrives first gets served before those who come later. This approach ensures fairness and order. It's like arranging books on a shelf – the one you place first is the one you'll pick up first. FIFO is widely used in banks, restaurants, and computer systems.

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What is the best example for LIFO? ›

Assume company A has 10 widgets. The first five widgets cost $100 each and arrived two days ago. The last five widgets cost $200 each and arrived one day ago. Based on the LIFO method of inventory management, the last widgets in are the first ones to be sold.

What is FIFO best used for? ›

The FIFO method is used for cost flow assumption purposes. In manufacturing, as items progress to later development stages and as finished inventory items are sold, the associated costs with that product must be recognized as an expense.

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What is FIFO in your own words? ›

What is the meaning FIFO? FIFO stands for First In, First Out. It is a method for organizing and managing data that is based on the principle that the item that is stored first is the item that is retrieved first. In other words, the oldest item in the system is the first one to be processed.

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What is a FIFO example? ›

Grocery store stock is a common example of using FIFO practices in real life. A grocery store will usually try to sell their oldest products first so that they're sold before the expiration date. This helps keep inventory fresh and reduces inventory write-offs which increases business profitability.

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What is LIFO in simple terms? ›

What does last in, first out mean? Last in, first out (LIFO) refers to a method for organizing and managing a data structure or collection in which the last item added is the first one to be removed. It is the opposite of first in, first out (FIFO), where the first item added is the first one to be removed.

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What are the applications of LIFO? ›

By using this method, you'll assume the most recently produced or purchased items were sold first, resulting in higher costs and lower profits, all while reducing your tax liability. LIFO is often used by gas and oil companies, retailers and car dealerships.

Why is LIFO not allowed? ›

IFRS prohibits LIFO due to potential distortions it may have on a company's profitability and financial statements. For example, LIFO can understate a company's earnings for the purposes of keeping taxable income low. It can also result in inventory valuations that are outdated and obsolete.

What is an example of first in first out in real life? ›

Examples of FIFO queuing in real life

Most queues that we encounter throughout the day are FIFO queues. Waiting for the bus, waiting in front of the elevator or a vending machine, or even standing in line to the bathroom all share one quality — the person standing in the front goes before the one standing behind.

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What is the difference between FIFO and LIFO quizlet? ›

* FIFO (first-in-first-out) assumes merchandise is sold in the order it was acquired by a firm. * LIFO (last-in-first-out) assumes merchandise is sold in the reverse of the order it was acquired by a firm.

What is the difference between LIFO and FIFO stack? ›

The primary difference between Stack and Queue Data Structures is that Stack follows LIFO while Queue follows FIFO data structure type. LIFO refers to Last In First Out. It means that when we put data in a Stack, it processes the last entry first. Conversely, FIFO refers to First In First Out.

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What is the difference between LIFO and FIFO food? ›

Should restaurants use LIFO? The short answer is no. The higher cost of goods sold brought on by the LIFO model and will ultimately yield lower restaurant profit margins and net income. Also, unlike FIFO, the last-in, first-out method doesn't always provide an accurate valuation of closing inventory.

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What is the main difference between FIFO and LIFO methods of pricing of material issues? ›

The difference between FIFO and LIFO is that the LIFO method sells or uses the oldest inventory first while the FIFO method sells or uses the newest inventory first. To better understand how they differ, let's look at some real-life examples.

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