Why would a company use LIFO instead of FIFO?

The main reason to use a LIFO inventory system rather than a FIFO inventory system is for tax purposes.Due to rising costs, newer inventory is typically more expensive than older inventory. This means that if you assume that those goods are sold first - and you haven't raised your prices - then you have a lower profit margin. A lower profit margin can put you in a lower tax bracket.For certain goods, the newest model is the one that tends to sell out first, as well, which means that it isn't inherently misleading. However, this method of inventory is only used in the United States, as international standards don't allow it.

Do most companies use LIFO or FIFO?

Most companies use a FIFO system rather than a LIFO system. As a rule, it more accurately reflects the flow of goods, which means it ends up being a more accurate accounting system.Also, if the company is international, it's generally easier to do all of your accounting via FIFO rather than accounting via LIFO in the United States and FIFO abroad.

Which is a better method, FIFO or LIFO?

FIFO is largely considered the better inventory accounting method. Most accountants and businesses see it as more honest, accurate, and reliable than LIFO. The IRFS doesn't even allow for LIFO as an inventory accounting method, meaning that it can't be used outside the United States.LIFO, however, is accepted by GAAP and does have certain advantages in terms of its accounting - mostly for tax purposes.

FIFO Vs. LIFO: What’s The Difference?

Business Terms

Both first in, first out (FIFO) and last in, last out (LIFO) are inventory practices. They’re most often put in their acronym forms, which makes them difficult to tell apart. But even when they aren’t, you may wonder: What exactly does that mean? How does inventory management even work?

The main reason to select one or the other isn’t for the sales itself – though it is good with perishable goods to try to get the oldest out before it expires – but for calculating assets. Both FIFO and LIFO are used for accounting and tax purposes.

Both terms are descriptive of the practice, with FIFO meaning that the oldest inventory is what the company seeks to sell first. LIFO is the opposite, with the business trying to sell the newest inventory first.

There are advantages and disadvantages to both types of inventory. FIFO is more obvious, especially if the business sells perishable goods. LIFO can give a company benefits in terms of taxes and may even be a better practice with certain types of sales, such as automobiles.

Key Takeaways:

First In, First Out (FIFO)	Last In, First Out (LIFO)
An inventory method where the oldest goods are assumed to be sold first.	An inventory method where the newest goods are assumed to be sold first.
Is an accepted method by both the International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP).	Is an allowed type of accounting by the Generally Accepted Accounting Principles (GAAP), meaning that it can be used in the United States, but the International Financial Reporting Standards (IFRS) don’t allow it.
FIFO is a straightforward method to track inventory and the flow of goods, allowing for a calculation of assets. Using the FIFO system usually makes the company’s profits appear higher than LIFO does.	LIFO is a more complicated calculation and is usually less accurate. It does, however, usually end up showing the company’s profits as lower than FIFO does.
This is the more common system used for groceries, technology, and horticulture.	This is the less common method, but it’s often used for automobiles, fuel, and jewelry.

What Is First In, First Out (FIFO)?

First in, first out (FIFO) is exactly what it sounds like: the oldest product is the first to be sold. This is the most common inventory practice and the generally favored one. Inventory like this is most often used in retail, which of course, means that the ideal isn’t met.

For instance, a grocery store may push the oldest stock to the front of the shelf to encourage customers to select that one first, but that’s not how it’ll always work. And some goods sell more slowly than others, meaning that stock will stay around longer.

Despite the fact that FIFO is an inventory practice, the purpose of using FIFO isn’t just to make sure that goods are sold before they spoil – it’s also an accounting tool. Inventory is a huge part of a business’s assets. Due to that fact, there needs to be a way to calculate a business’s worth and compare how much they spent on inventory versus what they made on sales.

The International Financial Reporting Standards (IFRS) only accept FIFO accounting, meaning that an international company is much more likely to use it. A few will use a LIFO accounting system in the United States, as the standards in America, the Generally Accepted Accounting Principles (GAAP), allow it, then switch to FIFO for their international reporting.

While FIFO is more common in general, there are certain goods that are typically inventoried this way. These include:

Groceries
Health care related goods
Horticulture
Technology

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What Is Last in, First Out (LIFO)?

LIFO is an inventory method that assumes that the last product you get in is the first one you’ll sell. It sounds counterintuitive, but there are uses for it in terms of tax purposes and for certain kinds of goods.

As with FIFO, LIFO is used as an accounting method. As with most things, costs tend to rise, meaning that newer inventory is likely to be more expensive than older inventory, so it follows that the business may make less of a profit selling its newest goods.

That means that using the LIFO accounting system will make the company’s profits look lower, which is good for tax purposes.

These calculations are all based on the cost of goods sold (COGS), which is a standard calculation in accounting. It takes into account how much the business paid for the goods and then compares it with what they sold for – and how many were sold.

Unsold goods are kept as inventory and, therefore, part of the company’s assets. In a LIFO system, however, those goods may or may not be viable, either due to being perishable or becoming obsolete.

While GAAP accepts LIFO as an accounting system, the IRFS doesn’t, which is one of the reasons it’s a less popular accounting system. FIFO usually more accurately represents the flow of goods than LIFO, which is another reason the former is often preferred.

It is, however, the preferred method for certain types of goods. These include:

Jewelry
Vehicles
Gasoline

First In, First Out (FIFO) vs. Last in, First Out (LIFO) FAQ

Why would a company use LIFO instead of FIFO?

The main reason to use a LIFO inventory system rather than a FIFO inventory system is for tax purposes.

Due to rising costs, newer inventory is typically more expensive than older inventory. This means that if you assume that those goods are sold first – and you haven’t raised your prices – then you have a lower profit margin. A lower profit margin can put you in a lower tax bracket.

For certain goods, the newest model is the one that tends to sell out first, as well, which means that it isn’t inherently misleading. However, this method of inventory is only used in the United States, as international standards don’t allow it.
Do most companies use LIFO or FIFO?

Most companies use a FIFO system rather than a LIFO system. As a rule, it more accurately reflects the flow of goods, which means it ends up being a more accurate accounting system.

Also, if the company is international, it’s generally easier to do all of your accounting via FIFO rather than accounting via LIFO in the United States and FIFO abroad.
Which is a better method, FIFO or LIFO?

FIFO is largely considered the better inventory accounting method. Most accountants and businesses see it as more honest, accurate, and reliable than LIFO. The IRFS doesn’t even allow for LIFO as an inventory accounting method, meaning that it can’t be used outside the United States.

LIFO, however, is accepted by GAAP and does have certain advantages in terms of its accounting – mostly for tax purposes.

Business Terms

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Author

Di Doherty

Di has been a writer for more than half her life. Most of her writing so far has been fiction, and she’s gotten short stories published in online magazines Kzine and Silver Blade, as well as a flash fiction piece in the Bookends review. Di graduated from Mary Baldwin College (now University) with a degree in Psychology and Sociology.

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