INTRODUCTION:

FIFO and LIFO are two different ways to account for the cost of inventory. FIFO stands for First In First Out, while LIFO stands for Last In First Out. It is important to understand the differences between the two because the COGS (cost of goods sold) line item on an income statement is affected by your choice of LIFO vs. FIFO accounting as is the valuation of inventory on the balance sheet. As a result, a company can impact both its earnings and current assets simply through its choice of inventory cost accounting measures.

It's worth noting that there are other methods of inventory accounting beside LIFO and FIFO, such as the specific identification method, but those are outside the scope of this article.

DEFINITION OF LIFO:

LIFO means that the inventory that you bought in the past is the last inventory to be sold and likewise that the inventory you purchased most recently is the inventory you sell most recently. Think about a giant pile of coal. The coal on the bottom of the pile was the first coal to be placed there, whereas the coal on the top of the pile was the most recent (or last) coal placed there. Now, when you go to sell the coal, obviously you are going to sell the coal on the top of the pile first - you aren't going to sell the coal buried on the bottom of the pile. In fact, you may never sell the coal on the bottom of the pile.

DEFINITION OF FIFO:

FIFO, on the other hand means the exact opposite. Namely, that the inventory you purchased in the past will be the first inventory that you sell, whereas the inventory that you purchased most recently will be the inventory you sell later. As an example, think about the milk in your grocer's refrigerator. As the grocer buys the milk (i.e. the inventory) he pushes it to the front of the frig and replaces newer milk behind it. In other words, the cartons of milk with the most recent dates are always the first cartons to be sold and the cartons with the later dates are only sold after the newer milk has already been sold.

INFLATION AND ITS IMPACT ON ACCOUNTING FOR INVENTORY:

Why is this seemingly meaningless difference in accounting methods important? Well, if you turnover your inventory very quickly (as is the case with milk) it is probably not that big of a deal. However, if your inventory turns over very slowly it can have a major impact. Consider again the pile of coal. Who knows how long those first pieces of coal on the bottom of the pile have been

• 1
• 2
• 3
• next page >>

---

Add your voice

Know something about Understanding the difference between FIFO and LIFO?
We want to hear your view. Write now!