What is FIFO?

FIFO is an acronym for first in, first out. It is a cost layering concept under which the first goods purchased are assumed to be the first goods sold. This approach is especially common when goods are expected to age over time, so it makes sense to eliminate the oldest items from stock first.

What is LIFO?

LIFO is a contraction of the term "last in, first out," and means that the goods last added to inventory are assumed to be the first goods removed from inventory for sale. This approach is most commonly used in an inflationary environment, where the cost of the newest items tends to be higher than the cost of older items. By shifting the cost of newer items directly into the cost of goods sold when goods are sold, a business can increase its reported cost of goods sold, and therefore lower its reported income.

Comparing FIFO and LIFO

Why use one method over the other? Here are some considerations that take into account the fields of accounting, materials flow, and financial analysis:

In essence, the primary reason for using LIFO is to defer the payment of income taxes in an inflationary environment. Despite this, LIFO accounting is not recommended, for several reasons. First, it is not allowed under IFRS, and a large part of the world uses the IFRS framework. Second, the number of layers to track can be substantially larger than would be the case under FIFO. Third, if old layers are accessed, costs may be charged to expense that vary substantially from current costs.