FIFO vs LIFO: What's the Difference? (2023 Update)
In this FIFO vs LIFO article, we explore the unique features of FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) for inventory valuation and compare their differences. Read on to learn more.
What is FIFO?
FIFO (First-In, First-Out) is an inventory valuation method that assumes the first items purchased or produced are the first to be sold or used. Simply put, the oldest inventory is sold before the newer inventory.
Unique Features of FIFO
Chronological Consumption: FIFO follows a chronological order, reflecting the actual flow of inventory within a business.
Matches Current Costs: FIFO tends to match recent purchase costs with current market prices, making it beneficial during inflationary periods.
Smooth Profit Margins: It often results in a smoother and more stable gross profit margin as older, lower-cost inventory is used first.
Higher Ending Inventory Value: FIFO typically yields a higher ending inventory value on the balance sheet.
Generally Accepted: FIFO is widely accepted under generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).
What is LIFO?
LIFO (Last-In, First-Out), on the other hand, is an inventory valuation method that assumes the most recently acquired or produced items are the first to be sold or used. In other words, the newest inventory is sold before the older inventory.
Unique Features of LIFO
Reverse Chronological Consumption: LIFO follows a reverse chronological order, which may not reflect the actual flow of inventory.
Lower Taxable Income: LIFO can result in lower taxable income during inflationary periods due to the use of higher-cost inventory, which can lead to tax advantages.
Volatile Profit Margins: It often results in more volatile gross profit margins as the cost of goods sold fluctuates with changing inventory costs.
Lower Ending Inventory Value: LIFO typically yields a lower ending inventory value on the balance sheet.
Limited Acceptance: LIFO is less accepted under IFRS and is subject to certain restrictions in GAAP, making it less commonly used in some industries.
LIFO vs FIFO: What's the Difference?
Cost Flow Assumption:
LIFO: Assumes that the newest inventory items are sold first, which may not always align with the physical flow of goods.
FIFO: Assumes that the oldest inventory items are sold first, which matches the physical flow of goods in many industries.
Impact on Profit and Taxes:
LIFO: Tends to result in lower reported profits during rising prices as it matches higher current costs with current revenue, potentially reducing income tax liabilities.
FIFO: Tends to result in higher reported profits during periods of rising prices because it matches lower historical costs with current revenue. This can lead to higher income taxes.
Balance Sheet Presentation:
LIFO: Results in a lower inventory valuation on the balance sheet during rising prices, as it reflects the higher, more recent costs.
FIFO: Results in a higher inventory valuation on the balance sheet during periods of rising prices, reflecting the older, lower-cost inventory.
LIFO: May underestimate a company's liquidity because it values inventory at older, lower costs.
FIFO: Can provide a more accurate representation of the company's ability to generate cash from its inventory, making it favorable for some lenders and investors.
Complexity and Record-Keeping:
LIFO: Can be more complex to administer due to the need to track the specific cost of each inventory item as it enters the inventory pool.
FIFO: Generally simpler to implement and requires fewer record-keeping adjustments, making it easier to manage for many businesses.
In summary, FIFO and LIFO are two distinct inventory valuation methods, each with its own set of unique features and implications for businesses. We hope that our LIFO vs FIFO comparison has given you a better understanding of the key differences between the two.