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FIFO and LIFO accounting are methods used in managing
inventory Inventory (American English American English (AmE, AE, AmEng, USEng, en-US), sometimes called United States English or U.S. English, is the set of varieties of the English language native to the United States. Currently, American English ...
and financial matters involving the amount of money a company has to have tied up within inventory of produced goods, raw materials, parts, components, or feedstocks. They are used to manage assumptions of costs related to inventory, stock repurchases (if purchased at different prices), and various other accounting purposes. The following equation is useful when determining inventory costing methods: : \text + \text = : \text + \text


FIFO

"FIFO" stands for ''first-in, first-out'', meaning that the oldest inventory items are recorded as sold first (but this does not necessarily mean that the exact oldest physical object has been tracked and sold). In other words, the cost associated with the inventory that was purchased first is the cost expensed first. A company might use the LIFO method for accounting purposes, even if it uses FIFO for
inventory management Field inventory management commonly known as inventory management is the function of understanding the stock mixStock mix is the combination of Product (business), products a company sells or manufactures. The stock mix is determined by the demand ...
purposes (i.e., for the actual storage, shelving, and sale of its merchandise). For example, a company that sells many perishable goods, such as a
supermarket A supermarket is a self-service Retail#Types of outlets, shop offering a wide variety of food, Drink, beverages and Household goods, household products, organized into sections. This kind of store is larger and has a wider selection than earli ...

supermarket
chain, is likely to follow the FIFO method when managing inventory, to ensure that goods with earlier expiration dates are sold before goods with later expiration dates. However, this does not preclude that same company from accounting for its merchandise with the LIFO method. With FIFO, the cost of inventory reported on the balance sheet represents the cost of the inventory most recently purchased. FIFO most closely mimics the flow of inventory, as businesses are far more likely to sell the oldest inventory first. Consider this example: Foo Co. had the following inventory at hand, in order of acquisition in November: If Foo Co. sells 210 units during November, the company would expense the cost associated with the first 100 units at $50 and the remaining 110 units at $55. Under FIFO, the total cost of sales for November would be $11,050. The ending inventory would be calculated the following way: Thus, the balance sheet would now show the inventory valued at $5250.


FIFO Tax Implications

FIFO will have a higher ending inventory value and lower cost of goods sold (COGS) compared to LIFO in a period of rising prices. Therefore, under these circumstances, FIFO would produce a higher gross profit and, similarly, a higher income tax expense.


LIFO

"LIFO" stands for ''last-in, first-out'', meaning that the most recently produced items are recorded as sold first. Since the 1970s, some U.S. companies shifted towards the use of LIFO, which reduces their income taxes in times of
inflation In economics, inflation refers to a general progressive increase in prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a r ...

inflation
, but since
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus ...
(IFRS) banned LIFO, more companies returned to FIFO. LIFO is used only in the United States, which is governed by the
generally accepted accounting principles Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms oper ...
(GAAP). Section 472 of the
Internal Revenue Code The Internal Revenue Code (IRC), formally the Internal Revenue Code of 1986, is the domestic portion of federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large The ''United States Sta ...

Internal Revenue Code
directs how LIFO may be used. In the example above, the company (Foo Co.) (using LIFO accounting) would expense the cost associated with the first 75 units at $59, 125 more units at $55, and the remaining 10 units at $50. Under LIFO, the total cost of sales for November would be $11,800. The ending inventory would be calculated the following way: The balance sheet would show $4500 in inventory under LIFO. The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the ''LIFO reserve'' (in the example above, it is $750). This reserve is essentially the amount by which an entity's taxable income has been deferred by using the LIFO method. In most sets of accounting standards, such as the International Financial Reporting Standards, FIFO (or LIFO) valuation principles are "in-fine" subordinated to the higher principle of
lower of cost or market Lower of cost or market (LCM or LOCOM) is a conservative Conservatism is an aesthetic Aesthetics, or esthetics (), is a branch of philosophy that deals with the nature of beauty and taste (sociology), taste, as well as the philosophy ...
valuation. In the United States, publicly traded entities which use LIFO for taxation purposes must also use LIFO for financial reporting purposes but such companies are also likely to report a LIFO reserve to their
shareholders A shareholder (in the United States often referred to as stockholder) of a corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal ...
. A number of tax reform proposals have argued for the repeal of LIFO tax provision. The "Save LIFO Coalition" argues in favor of the retention of LIFO.About Save LIFO Coalition
accessed 23 December 2016


References


External links


Taxpolicycenter.org
"Tax Topics: Repeal LIFO" *
FIFO Guide
I Pass the CPA Exam. {{Authority control Inventory Accounting terminology