FIFO and LIFO
Also known as: first-in, first-out and last-in, first-out
FIFO (first-in, first-out) and LIFO (last-in, first-out) are inventory cost flow assumptions. FIFO expenses the oldest inventory costs first, while LIFO expenses the newest costs first, producing different cost of goods sold and ending inventory values.
FIFO and LIFO are the two best-known cost flow assumptions companies use to assign costs to inventory sold. Because identical units are often purchased at different prices over time, accounting needs a rule for which costs move to cost of goods sold (COGS) and which remain in ending inventory. FIFO (first-in, first-out) assumes the oldest costs are sold first; LIFO (last-in, first-out) assumes the most recent costs are sold first. The assumption is about cost flow, not the physical movement of goods.
A quick example: a company buys 100 units at $10, then 100 units at $12, and sells 100 units. Under FIFO, COGS is $1,000 (the older $10 units) and ending inventory is $1,200. Under LIFO, COGS is $1,200 (the newer $12 units) and ending inventory is $1,000.
The choice matters most when prices are changing. In a period of rising prices, FIFO reports lower COGS, higher net income, and a higher ending inventory balance; LIFO reports higher COGS, lower net income, and lower taxable income — a key reason some U.S. companies elect it. LIFO is permitted under U.S. GAAP but prohibited under IFRS, which is a frequently tested distinction. A weighted-average method sits between the two extremes.
The CMA Part 1 exam tests FIFO and LIFO within inventory accounting. Be prepared to compute COGS and ending inventory under each assumption, in both periodic and perpetual systems, and to explain how each method affects net income and taxes when prices rise or fall.
Key takeaways
- FIFO expenses the oldest inventory costs first; LIFO expenses the newest costs first.
- They are cost flow assumptions and need not match the physical flow of goods.
- When prices rise, FIFO yields higher net income and ending inventory, while LIFO yields higher COGS and lower taxable income.
- LIFO is allowed under U.S. GAAP but prohibited under IFRS.
- CMA Part 1 tests computing COGS and ending inventory under FIFO, LIFO, and weighted average.