Introduction
In accounting, there are two methods used to valuation inventories, these are FIFO vs LIFO. FIFO is an acronym for “First In, First Out” and LIFO is an acronym for “Last In, First Out”. Both methods are used to Cost of Goods Sold (COGS), but there are some key differences that you should be aware of.
What is FIFO?
FIFO stands for First In, First Out. It is a method used to account for inventory where the inventory that is first purchased is also the first inventory to be sold.
This method of accounting is used in businesses where the inventory turnover is high and the cost of goods sold is relatively low. FIFO results in a lower cost of goods sold because the inventory that is first purchased is also the first inventory to be sold.
LIFO, on the other hand, stands for Last In, First Out. It is a method used to account for inventory where the inventory that is last purchased is also the first inventory to be sold.
This method of accounting is used in businesses where the inventory turnover is low and the cost of goods sold is relatively high. LIFO results in a higher cost of goods sold because the inventory that is last purchased is also the first inventory to be sold.
What is LIFO?
LIFO, or last in first out, is a method used to account for inventory. In essence, the most recent products added to inventory are the first ones sold. The key benefit of LIFO is that it more accurately matches current costs with current revenue, which can produce lower taxes in times of inflation.
Inventory management can be a complex process, but understanding the difference between LIFO and FIFO accounting methods is a good place to start.
Advantages and disadvantages of FIFO
When analyzing inventory, two common systems used are FIFO and LIFO. While both systems aim to track and evaluate inventory in a company, they use different methods to do so. Here is a break down of the advantages and disadvantages of each system:
FIFO – First In First Out
Advantages:
-More accurate representation of true cost of goods sold
-Inventory cost is matched with revenue from sales
-Simple to calculate and maintain
Disadvantages:
-Can produce high income taxes in periods of rising prices
-Assumes that older inventory is sold first, which may not always be the case
LIFO – Last In First Out
Advantages:
-Lower income taxes in periods of rising prices
-Assumes that newer, more expensive inventory is sold first, which may be more reflective of reality
-Easier to calculate than other methods when prices are constantly changing
Disadvantages:
-More difficult to calculate than other methods when prices are constantly changing
-Inventory cost may not match revenue from sales
Advantages and disadvantages of LIFO
LIFO has several advantages and disadvantages, which must be considered when making management decisions.
Advantages of LIFO:
-LIFO limits the impact of inflation on financial statements.
-LIFO provides a more realistic picture of current inventory levels.
-LIFO can result in lower taxes.
Disadvantages of LIFO:
-LIFO can lead to distorted financial statements.
-LIFO can encourage managers to stockpile inventory.
Conclusion
So, what is the difference between FIFO and LIFO? In short, FIFO is an inventory valuation method that assumes that the first items purchased are the first items sold, while LIFO assumes that the last items purchased are the first items sold. While both methods have their pros and cons, most companies prefer to use FIFO because it more accurately reflects the true cost of inventory.