FIFO vs LIFO differences, examples, and formulas for 2025

Inventory value is then calculated by adding together the unique prices of every inventory unit. Rather, every unit of inventory Bookkeeping for Veterinarians is assigned a value that corresponds to the price at which it was purchased from the supplier or manufacturer at a specific point in time. If suppliers or manufacturers suddenly raise the price of raw materials or goods, a business may find significant discrepancies between their recorded vs. actual costs and profits. Due to inflation over time, inventory acquired more recently typically costs more than older inventory. With the FIFO method, since the older goods of lower value are sold first, the ending inventory tends to be worth a greater value.

What is the FIFO method?

The $1.25 loaves would be allocated to ending inventory on the balance sheet. For many companies, inventory represents a large, if not the largest, portion of their assets. Inventory can be valued using a few different accounting methods, including first In, first out (FIFO) and last in, first out (LIFO).

What Is The FIFO Method? FIFO Inventory Guide

This method is often used during periods of inflation, as it results in higher COGS and lower taxable income, but example of fifo it may not reflect the actual physical flow of inventory. Generally Accepted Accounting Principles (GAAP) but not allowed under International Financial Reporting Standards (IFRS). This results in deflated net income costs in inflationary economies and lower ending balances in inventory compared to FIFO. The inventory item sold is assessed a higher cost of goods sold under LIFO during periods of increasing prices. Under FIFO, when 60 units are sold, the COGS remains $600 (60 units x $10 per unit).

Why Is the FIFO Method Popular?

The FIFO (First-In, First-Out) cost method is a vital tool in inventory management and cost accounting. It ensures that older inventory costs are matched with revenues, providing a realistic portrayal of COGS and inventory valuation. LIFO (Last In, First Out) is an accounting method used for inventory valuation, where the most recently acquired items are assumed to be sold or used first. Under LIFO, the cost of the latest inventory purchased is the first to be recorded as the cost of goods sold (COGS), leaving older inventory as ending stock.

Disadvantages of the FILO process:

The alternate method of LIFO allows companies to list their most bookkeeping recent costs first in jurisdictions that allow it. FIFO means « First In, First Out. » It’s a valuation method in which older inventory is moved out before new inventory comes in. By using FIFO, the balance sheet shows a better approximation of the market value of inventory. The latest costs for manufacturing or acquiring the inventory are reflected in inventory, and therefore, the balance sheet reflects the approximate current market value. Inventory valuation can be defined as the amount correlating with the goods in the inventory at the end of the reporting or accounting period. This value is generated after considering the expenses incurred to acquire the stock and preparing it for sale.

FIFO vs. Specific Inventory Tracing

You will most likely sell a product manufactured in January 2019 before the one made in August 2019. If the company sold 5 shirts for the year, Fifo would report costs of goods sold as $35 (5 shirts purchased in May at $7 per shirt). This FIFO cost does not take into full consideration the newer $8.50 per shirt cost of restocking the inventory. In fact, by the time to company will have to purchase more inventory the costs might go up even more than $8.50.

Step 1: Identify the cost of your newest inventory

However, the LIFO method may not represent the actual movement of inventory. Depending on the actual shelf life, this may not reflect the real value of the company’s inventory. Assuming that prices are rising, this means that inventory levels are going to be highest because the most recent goods (often the most expensive) are being kept in inventory.

• If the bakery sells 200 loaves on Wednesday, the COGS—on the income statement—is $1.25 per loaf.
• In stores, FIFO is usually implemented by using the oldest receipts to calculate the cost of goods sold.
• The companies use these methods to estimate the inventory costs and how they will impact their profits.
• Since it does not take into account specific sales from inventory batches, you never know if you actually made that big a profit or if it is significantly smaller.
• As we will discuss below, the FIFO method creates several implications on a company’s financial statements.

The advantages and disadvantages of FIFO and FILO

The purpose of FIFO is to ensure proper stock rotation, minimize waste, and maintain the quality of products, especially perishable or time-sensitive goods. FIFO is a straightforward approach to inventory valuation that suits many business operations. Many companies prefer it due to its close alignment with physical inventory flow. Retail businesses, manufacturers, and companies dealing with perishable goods find it particularly valuable.

This is a more practical and efficient approach to the accounting for inventory which is why it is the most common approach adopted. As the company acquires additional inventory, each transaction must be recorded in detail. For example, the business purchases 100 units at $9 each, followed by another 100 units at $10 each. These records form the basis for calculating COGS and ending inventory under both methods. Proper documentation ensures compliance with accounting standards and supports accurate financial analysis. FIFO (First-In, First-Out) is an inventory costing method where the oldest inventory items are assumed to be sold first.