LIFO vs FIFO: Inventory Methods Compared | CPA FAR Guide
LIFO vs FIFO: Differences, Examples & CPA Guide
LIFO (Last-In, First-Out) and FIFO (First-In, First-Out) are the two primary inventory costing methods under US GAAP. FIFO assumes the oldest inventory is sold first, while LIFO assumes the newest inventory is sold first. The method a company chooses directly impacts cost of goods sold, net income, taxes, and the balance sheet. LIFO is permitted under US GAAP but prohibited under IFRS, making this a critical comparison topic on the CPA FAR exam.
- FIFO: oldest costs go to COGS first, resulting in higher net income and higher ending inventory during inflation
- LIFO: newest (higher) costs go to COGS first, resulting in lower net income and tax savings during inflation
- LIFO is allowed under US GAAP but banned under IFRS
- The LIFO reserve measures the difference between LIFO and FIFO inventory values
- CPA FAR tests calculations under both periodic and perpetual systems
Table of Contents
- What Are LIFO and FIFO?
- Side-by-Side Comparison
- Worked Example With Calculations
- Journal Entries
- Impact on Financial Statements
- IFRS vs US GAAP
- When to Use Each Method
- Common Mistakes to Avoid
- Quick Glossary
- Frequently Asked Questions
What Are LIFO and FIFO?
LIFO (Last-In, First-Out): Assumes the most recently purchased inventory is sold first. Ending inventory reflects the oldest purchase costs.
Side-by-Side Comparison
| Feature | FIFO | LIFO |
|---|---|---|
| Cost Flow Assumption | Oldest costs to COGS first | Newest costs to COGS first |
| COGS (during inflation) | Lower | Higher |
| Net Income (during inflation) | Higher | Lower |
| Ending Inventory Value | Higher (recent costs) | Lower (older costs) |
| Tax Impact (during inflation) | Higher taxes | Lower taxes (tax savings) |
| US GAAP | Allowed | Allowed |
| IFRS | Allowed | Prohibited |
| Balance Sheet Accuracy | More accurate (current costs) | Less accurate (outdated costs) |
Worked Example: FIFO vs LIFO Calculation
Scenario: A company has the following inventory purchases and sales in October:
| Date | Transaction | Units | Cost/Unit | Total |
|---|---|---|---|---|
| Oct 1 | Beginning Inventory | 100 | $10 | $1,000 |
| Oct 10 | Purchase | 150 | $12 | $1,800 |
| Oct 20 | Purchase | 100 | $14 | $1,400 |
| Oct 25 | Sale | 200 | - | - |
Total units available: 350 | Units sold: 200 | Units remaining: 150
COGS = 100 units x $10 + 100 units x $12 = $2,200
Ending Inventory = 50 units x $12 + 100 units x $14 = $2,000
Check: $2,200 + $2,000 = $4,200 (total cost of goods available)
COGS = 100 units x $14 + 100 units x $12 = $2,600
Ending Inventory = 100 units x $10 + 50 units x $12 = $1,600
Check: $2,600 + $1,600 = $4,200 (total cost of goods available)
| Metric | FIFO | LIFO | Difference |
|---|---|---|---|
| COGS | $2,200 | $2,600 | $400 |
| Ending Inventory | $2,000 | $1,600 | $400 |
| Gross Profit (if sales = $4,000) | $1,800 | $1,400 | $400 |
LIFO Reserve = FIFO Inventory - LIFO Inventory = $2,000 - $1,600 = $400
Journal Entries: FIFO vs LIFO
The journal entries for recording sales are identical regardless of method. The difference is in the amount allocated to COGS:
Under FIFO:
Dr Cost of Goods Sold $2,200
Cr Inventory $2,200
Under LIFO:
Dr Cost of Goods Sold $2,600
Cr Inventory $2,600
Impact on Financial Statements
| Financial Statement | FIFO Effect (Rising Prices) | LIFO Effect (Rising Prices) |
|---|---|---|
| Income Statement | Lower COGS, higher gross profit, higher net income | Higher COGS, lower gross profit, lower net income |
| Balance Sheet | Higher inventory value, higher current assets | Lower inventory value, lower current assets |
| Cash Flow | Higher tax payments, lower operating cash flow | Lower tax payments, higher operating cash flow |
| Ratios | Higher current ratio, higher inventory turnover denominator | Lower current ratio, may distort inventory turnover |
IFRS vs US GAAP: Inventory Methods
| Aspect | US GAAP | IFRS (IAS 2) |
|---|---|---|
| FIFO | Permitted | Permitted |
| LIFO | Permitted | Prohibited |
| Weighted Average | Permitted | Permitted |
| Inventory Write-Down | Lower of cost or market (LCM); write-down is permanent | Lower of cost or NRV; reversal of write-down permitted |
| Standard | ASC 330 | IAS 2 |
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When to Use FIFO vs LIFO
| Use FIFO When | Use LIFO When |
|---|---|
| You need IFRS compliance | You want to minimise tax liability (US only) |
| You want higher reported earnings | You want to match recent costs with revenue |
| You sell perishable goods | You operate in a high-inflation environment |
| You want accurate balance sheet inventory | You prioritise cash flow over reported income |
Common Mistakes to Avoid
- LIFO liquidation: When a LIFO company sells more units than purchased, old low-cost layers are matched with current revenue, artificially inflating profits
- Forgetting the conformity rule: LIFO for tax requires LIFO for financial reporting
- Confusing periodic vs perpetual LIFO: Results differ under perpetual vs periodic LIFO (not so for FIFO)
- Assuming LIFO is available globally: LIFO is prohibited under IFRS
- Ignoring the LIFO reserve disclosure: Companies using LIFO must disclose the LIFO reserve to allow FIFO conversion
Quick Glossary
| Term | Plain-English Definition |
|---|---|
| COGS | Cost of Goods Sold — the total cost of inventory items sold during a period |
| LIFO Reserve | The difference between inventory under LIFO and what it would be under FIFO |
| LIFO Liquidation | When a company dips into old LIFO layers, matching old low costs against current revenue |
| Weighted Average | A third method that uses the average cost of all units available during the period |
| NRV | Net Realisable Value — estimated selling price minus costs to complete and sell |
| LCM | Lower of Cost or Market — US GAAP rule requiring inventory be valued at the lower amount |
Frequently Asked Questions
What is the main difference between LIFO and FIFO?
FIFO (First-In, First-Out) assumes the oldest inventory is sold first, while LIFO (Last-In, First-Out) assumes the newest inventory is sold first. This affects COGS, ending inventory, net income, and tax liability differently depending on price trends.
Is LIFO allowed under IFRS?
No. IAS 2 explicitly prohibits LIFO. Companies reporting under IFRS must use FIFO or weighted average cost. This is one of the most significant differences between US GAAP and IFRS inventory accounting.
Why do companies choose LIFO?
Companies choose LIFO primarily for tax benefits during inflationary periods. By matching higher recent costs against revenue, LIFO produces higher COGS, lower taxable income, and therefore lower tax payments, improving cash flow.
What is LIFO liquidation?
LIFO liquidation occurs when a company using LIFO sells more units than it purchases, dipping into older, lower-cost inventory layers. This results in artificially higher profits and increased tax liability, defeating the purpose of using LIFO.
How does LIFO vs FIFO affect taxes?
During rising prices, LIFO produces higher COGS and lower taxable income, resulting in lower taxes. FIFO produces lower COGS and higher taxable income, meaning higher taxes. The tax savings from LIFO can be significant during inflationary periods.
Can a company switch from LIFO to FIFO?
Yes, but switching inventory methods requires justification that the new method is preferable. Under US GAAP, the change must be applied retrospectively. Switching from LIFO to FIFO also triggers a tax recapture of the LIFO reserve, which can result in a significant tax bill.
What is the LIFO conformity rule?
The LIFO conformity rule (IRC Section 472) requires that if a company uses LIFO for tax purposes, it must also use LIFO for financial reporting. This is unique to LIFO and is a frequently tested concept on the CPA FAR exam.
CPA FAR Exam: How LIFO vs FIFO Is Tested
| Exam Focus Area | What to Know |
|---|---|
| COGS calculation | Be able to calculate COGS under both LIFO and FIFO given purchase data |
| Ending inventory | Know how to determine ending inventory values under each method |
| LIFO reserve | Convert LIFO inventory to FIFO using the LIFO reserve disclosure |
| LIFO liquidation | Recognise when liquidation occurs and its effect on profits |
| Conformity rule | LIFO for tax = LIFO for financial reporting (IRC 472) |
| LCM vs NRV | US GAAP uses LCM for LIFO; NRV for FIFO and weighted average |
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Vicky Sarin is the founder of Eduyush, a professional certification coaching platform. With years of experience in accounting education, Vicky helps CPA, ACCA, and DipIFR candidates master complex topics through clear, exam-focused content. Connect with Eduyush for CPA review courses and DipIFR coaching.
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