Difference Between FIFO and LIFO

FIFO vs LIFO
 

It is essential for a firm to keep count of the stock that is being purchased and sold in order to observe and determine the cost of inventory for the period. The calculation of this inventory cost can be done in a number of ways; two of the methods have been discussed in this article. It is important to note that the method of inventory cost calculation must be chosen on grounds that it provides the most realistic picture of the firm’s financial position, as this calculated figure will impact the cost of goods sold figure recorded in the income statement and the inventory value on the balance sheet, which in turn can impact financial decision making. The following article will give a clear picture of the two methods of inventory cost calculation, highlighting the differences between the two.

What is FIFO?

FIFO stands for first in first out, and under this method of inventory valuation, the inventory that was bought first will be utilized first. For example, if I buy 100 units of stock on the 1st December and purchase 200 units of stock on the 15th December the first to be used will be the 100 units of stock I bought on the 1st December as that was what I purchased first. This method of inventory valuation is usually used when perishable items such as fruits, vegetables or dairy products are sold, since it is essential to sell the first purchased goods as soon as possible before they perish.

What is LIFO?

LIFO stands for last in first out and under this method of inventory valuation, the inventory that was bought last will be utilized first. For example, if I purchase 50 units of stock on the 3rd January, 60 units of stock on the 25th January, and further 100 units of stock on the 16th February, the first stock to be utilized under the LIFO method would be the 100 units of stock I purchased on the February 16th since it was the last to be purchased. This method of stock valuation is most suitable for goods that do not expire, perish or become obsolete in a short period as it requires the goods bought to be held in stock for a longer period. An example for such goods can be coal, sand, or even bricks where the seller will always sell the sand, coal or bricks that were stocked on top first.

FIFO vs LIFO

When comparing the LIFO and FIFO, there are no similarities between the two except that they are both inventory valuation methods validated by accounting policies and principles, and can be used for stock valuation depending on how well they represent the firm’s financial position. The main differences between the two methods of valuation are the effect that they have on the firm’s income statements and balance sheet. In times of inflation, if the LIFO method of valuation is used, the stock that is sold will cost higher than the stock that remains. This will result in a higher COGS and lower inventory value in the balance sheet. If the FIFO method is used during inflation, the stock that is sold will cost lower than the stock held, which will lower the COGS and increase the inventory value in the firm’s balance sheet. The other difference between the two is in how they impact tax. LIFO method will result in higher COGS and will result in lower tax (since earnings are lower when cost of goods are high), and the FIFO method will result in higher tax since COGS is lower (earnings will be higher).