First-in, first-out (FIFO) and last-in, first-out (LIFO) are breaking methods used to value end inventory and the cost of products sold. The gaps between FIFO vs LIFO are easy. FIFO assumes the initial items sold are the first ones added to stock. Together with LIFO, the very first items sold would be the last items put into stock.
Manually calculating LIFO and FIFO is a hassle, but accounting software can make it simpler. QuickBooks automatically updates inventory based on purchases and recorded earnings. Behind the scenes, it does all the calculations that you value your cost of goods sold and ending inventory using the most common and widely employed busting method, FIFO.
What FIFO Is
FIFO is one of two common cost layering methods used by businesses that take inventory. Compared to LIFO, it’s the more logical choice since it follows exactly what most businesses do, which will be promote their oldest items . First-in, first-out signifies the items that were placed into inventory first (older items) are offered .
During times of increasing prices (inflation), the first items sold are the cheapest, so selling them results in a lower cost of goods sold and higher profits. Higher profits typically cause a larger tax bill. Please note: the first items sold may not be the least expensive if costs aren’t rising.
On the reverse side, the first items sold are the most expensive during times of decreasing costs (deflation). This results in a higher cost of products sold and lower profits and, finally, a reduced tax bill. Remember that in the event you decide to switch from FIFO to LIFO, you have to file IRS Form 970 to inform the IRS of the shift. Also, when you change to LIFO, you aren’t allowed to change to another accounting method without asking permission from the IRS.
The FIFO method is acceptable under generally accepted accounting principles (GAAP), which govern accounting standards for businesses that operate only in the United States. FIFO can also be approved by the International Financial Reporting Standards (IFRS), which regulates accounting standards for companies that operate outside of the USA.
What LIFO Can Be
LIFO is a common cost layering method used by businesses to value ending inventory and cost of goods sold. When comparing FIFO vs LIFO, LIFO is used less frequently because few companies sell their newer things before their older things. Last-in, first-out signifies the items placed into stock last (latest purchases) are offered .
The most recent purchases would be the most costly during times of rising prices. Under the LIFO method, this results in a higher cost of products sold and reduced gains. During times of deflation, the latest purchases are the cheapest. Under the LIFO method, this causes a lower cost of products sold and higher profits. Higher profits lead to a bigger tax bill.
1 key difference between LIFO and FIFO is you cannot use the LIFO method if your business operates internationally because it isn’t accepted by the IFRS. As mentioned before, the IFRS regulates accounting standards for companies that operate outside of the U.S.
Along with picking a costing method, company owners that have physical stock to track may want to download one of our free stock templates.
The Way to Calculate FIFO vs LIFO
To calculate FIFO and LIFO, you will need three key pieces of advice: beginning inventory, purchases, and sales for your period. After collecting this information, you have exactly what you need to determine the ending inventory and the cost of goods sold with the FIFO or LIFO method.
How to Calculate FIFO
FIFO is used to figure the cost of the items that you have sold, like the cost of goods sold, and the worth of your ending inventory. To figure out the cost of products sold, you multiply earnings for the period by the expense of the items that were placed into inventory first. To ascertain the value of the remaining stock, you utilize the expense of the latest buys because FIFO assumes those are the items which are left in inventory at the close of the period.
Below is a good example of how to calculate the price of goods sold with the FIFO system.
How to Calculate the Cost of Goods Sold Using FIFO
Below is an illustration of how to use the FIFO method using a fictitious firm, Custom T-Shirts, Inc..
Example: Let’s assume Custom T-Shirts, Inc began the year with 1,000 T-shirts in inventory and purchased a total of 3,000 T-shirts between January and March.
Beginning stock: 1,000
Less revenue: (3,000)
End inventory: 1,000