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LIFO and FIFO: What are the Differences and Applications?

You are currently viewing LIFO and FIFO: What are the Differences and Applications?

Have you been struggling to understand the difference between the two famous inventory accounting practices—FIFO and LIFO—or maybe just been pushing the thought that the two are not synonymous under the mat for quite some time now? If the answer to either or both is yes, then this article will enlighten you not just with what FIFO and LIFO are, but also how these two differ and which of the two is better in what kinds of scenarios.

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What is LIFO?

LIFO is an inventory accounting process and the word is an acronym for “Last In, First Out”. LIFO is approved according to the Generally Accepted Accounted Principles, but it is forbidden by the International Financial Reporting Standards. In LIFO, the cost of goods sold (COGS) most recently is used for working out the value of the ending inventory.

What is FIFO?

FIFO is an inventory estimation method and an acronym for “First In, First Out,” implying that the oldest goods to be produced or purchased in the inventory must be sold first. In FIFO, the COGS of the oldest inventory items is used for working out the cost value of the ending inventory.

How is LIFO different from FIFO?

LIFO is an inventory estimation method that works on the assumption that goods produced or purchased last are the first to be sold. This approach is only legally used by businesses based in the US. Meanwhile, FIFO works on the contrary principle that goods brought in as inventory first are sold out first, as well. It is a very common inventory evaluation method in several countries. Read on to learn more about the differences between the two.

In case of higher COGS and lesser profits, opting for LIFO requires businesses to pay lesser income tax. However, LIFO is less popular due to its complexity. Comparatively, FIFO is more commonly used, and it has higher transparency and accuracy. Businesses can enjoy higher amounts of net income while using FIFO, however LIFO is more profitable during times of inflation. Moreover, FIFO is a good choice for a wider range of inventory items particularly perishable goods, while LIFO doesn’t work out well for items with shorter shelf life.

Which is Better—FIFO or LIFO?

This depends on the nature of your business and your business priorities. Within the US, both methods are considered legal, while LIFO isn’t considered legal for most businesses that aren’t based in the US. It is best to consult with your CPA before deciding regarding your inventory evaluation method. That said, there are benefits to both. FIFO is known for its accuracy, transparency, and more profitable results. LIFO is a good choice for businesses that face lower profit margins and higher COGS, and deal with pricey, longer-shelf-life but shorter value-life items.

When Should You Use LIFO?

Since COGS of the latest inventory is the one that is used in LIFO, it’s beneficial to opt for this method when prices are on the rise. You should use LIFO if your business deals with huge amounts of expensive inventory or inventory that tends to lose its monetary value over time. All businesses must deal with inflation, but some are affected more, particularly if the kinds of goods they deal depreciate in value with passing time, such as automobiles.

Those who are against this method, comment that LIFO provides an unfair advantage on tax by twisting the value of inventory, in times of rise in prices. If you want to try LIFO for your eCommerce fulfillment business, you will need to discuss this with your CPO before legally switching to this method.

When Should You Use FIFO?

FIFO is the more popular and often consultant-recommended inventory estimation process. You should use FIFO if your order fulfillment services essentially require you to first move out older inventory, for instance if you deal in items with short shelf life, such as cosmetics or food products. This means that there is a higher chance you will be using the prices you actually paid in your balance statements, providing simple and accurate records.

You should also opt for FIFO if your business is based outside of the US. If you want to maximize your dock-to-stock efficiency by keeping only the essential amount of inventory in your warehouse storage, and avoiding carrying dead stock, FIFO will ease the process for you. Moreover, FIFO is the method to choose if you want your taxation figures to be transparent, accurate and not under scrutiny of the taxation authorities.

Collaborate with ShipBots for Well-informed Inventory-Related Decisions and Management

ShipBots are an expert in providing end-to-end eCommerce solutions to streamline your fulfillment process by efficiently organizing your physical inventory and optimizing your supply chain processes. At ShipBots we make data-driven decisions for accurate demand forecasting and use a digital warehouse for keeping a track on the movement of inventory. We make use of the FIFO approach and digitize your inventory management for fast and precise tracking. To expand your business with our 3PL fulfillment services, you can request a quote.