What Is FIFO vs LIFO and Which Inventory Method Should You Use?
Sam's List Editorial | 2026-07-27
What Is FIFO vs LIFO and Which Inventory Method Should You Use? FIFO and LIFO are cost flow assumptions. FIFO, first in first out, assumes the oldest units you bought are the ones you sold. LIFO, last in first out, assumes the newest units sold first. Neither claims to track which physical box left the warehouse. They are rules for deciding which cost moves to cost of goods sold, and when prices are changing, the two produce different profit and a different tax bill from identical sales. That last sentence is the entire reason anyone cares about FIFO vs LIFO. Same units in, same units out, same revenue, different profit. Here is the math, then the rules that constrain your choice. The Same Sales, Two Different Profits You bought inventory in three lots as your supplier's prices rose: 100 units at 10 dollars = 1,000 dollars 100 units at 12 dollars = 1,200 dollars 100 units at 15 dollars = 1,500 dollars That is 300 units and 3,700 dollars of cost on hand. You then sell 150 units at 25 dollars each, for 3,750 dollars of revenue. Under FIFO, the oldest costs move first: 100 units at 10 plus 50 units at 12. Cost of goods sold is 1,600 dollars. Gross profit is 2,150 dollars, and 2,100 dollars of cost stays in ending inventory. Under LIFO, the newest costs move first: 100 units at 15 plus 50 units at 12. Cost of goods sold is 2,100 dollars. Gross profit is 1,650 dollars, and 1,600 dollars of cost stays in ending inventory. Under weighted average cost, every unit carries the blended cost of 12.33 dollars. Cost of goods sold is 1,850 dollars and gross profit is 1,900 dollars. Five hundred dollars of gross profit separates FIFO from LIFO on a 3,750 dollar sale. Nothing about the business changed. Only the assumption did. Why the Direction Reverses When Prices Fall The general pattern holds when costs are rising: LIFO pushes newer, higher costs into COGS, which lowers reported profit and lowers taxable income, while leaving older, cheaper costs sitting in ending inventory on the balance sheet. When costs are falling, it flips. LIFO then moves the cheapest costs to COGS, raising reported profit. FIFO does the opposite. This matters because LIFO is often described as the tax-favorable method as though that were a permanent property. It is not. It is favorable in an inflationary environment for that particular input, and it can work against you when your supplier's prices decline. There is also a balance sheet cost to LIFO in a rising-price environment. Ending inventory carries old, low costs, so the asset value on your balance sheet drifts further from replacement...
