What Is FIFO vs LIFO and Which Inventory Method Should You Use?
Sam's List Editorial | 2026-07-27
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 cost over time. Lenders and buyers notice.
FIFO vs LIFO vs Weighted Average Cost: Comparison Table
| FIFO | LIFO | Weighted average cost | |
|---|---|---|---|
| Cost assumption | Oldest units sold first | Newest units sold first | Every unit carries a blended cost |
| COGS when prices rise | Lower | Higher | In between |
| Reported profit when prices rise | Higher | Lower | In between |
| Ending inventory value when prices rise | Closer to current cost | Older, lower cost | In between |
| Permitted under US GAAP | Yes | Yes | Yes |
| Permitted under IFRS | Yes | No | Yes |
| Common fit | Most businesses, perishables, anything where inventory value should reflect current cost | US-only businesses with sustained input cost inflation and enough volume to justify the complexity | Commodities, blended or hard-to-distinguish units |
The Rules That Narrow Your Choice
Three constraints do most of the work here.
LIFO is a United States phenomenon. It is permitted under US GAAP and under the US tax code. It is prohibited under IFRS. If your business reports under IFRS, or you have foreign subsidiaries or investors who expect IFRS-comparable statements, LIFO creates a reconciliation problem you may not want.
The LIFO conformity requirement. If you elect LIFO for tax purposes, you are generally required to use LIFO in the financial statements and reports you issue to shareholders, partners, and creditors. You cannot report higher FIFO profit to your bank while claiming lower LIFO income on your return. That is the trade-off people underestimate: the tax benefit comes with reporting lower profit to everyone who reads your financials, including a lender assessing a credit line.
Switching is a formal accounting method change. Your inventory method is a method of accounting, and changing it generally requires consent from the IRS, requested on Form 3115. Electing LIFO in the first place is done on Form 970. Neither is a setting you change in your accounting software, and both come with computational requirements that persist afterward. LIFO in particular is administratively heavier because you maintain cost layers or pools indefinitely.
If You Are a Smaller Business, You May Have a Simpler Path
Businesses that meet the gross receipts test under section 448(c), which is an inflation-adjusted average of the three prior years, have simplified options for inventory. For 2026 that threshold is 32 million dollars. Qualifying taxpayers may generally treat inventory as non-incidental materials and supplies, or conform their tax treatment to the method used in their applicable financial statements, and that treatment is not disqualified for failing to clearly reflect income.
For a lot of small product businesses this means the FIFO versus LIFO debate is not the decision in front of them. The real decision is whether they are tracking inventory accurately at all. Ask an accountant which of these regimes applies to you before optimizing within one.
The Practical FIFO vs LIFO Answer for Most Businesses
Most small and midsize product businesses use FIFO, and it is usually the right default for three reasons. It matches how physical inventory actually moves in most operations, particularly anything perishable or subject to obsolescence. It leaves ending inventory close to current cost, which produces a balance sheet a lender can read. And it avoids the conformity requirement and the layer maintenance that come with LIFO.
LIFO is worth modeling when you have sustained, meaningful cost inflation in a major input, enough volume that the tax deferral is material, no IFRS reporting obligation, and no near-term plan to raise debt or sell where lower reported profit hurts you. That is a real set of conditions, and it is narrower than the amount of attention LIFO gets in accounting coursework suggests.
Whichever direction you lean, this is a decision to model with a CPA against your actual purchase history rather than to reason about in the abstract. Sam's List lists accountants and bookkeepers with their specialties, client types, and verified client reviews on each profile, including firms that work with inventory-heavy and product businesses.
Frequently Asked Questions
What is the difference between FIFO and LIFO? FIFO assumes the oldest inventory you purchased is the first sold, so older costs move to cost of goods sold. LIFO assumes the newest inventory sold first, so recent costs move to COGS. Neither tracks physical units. When purchase prices are rising, LIFO produces higher COGS and lower reported profit than FIFO from identical sales.
Is FIFO or LIFO better for taxes? Neither is universally better. When your input costs are rising, LIFO generally produces higher COGS and therefore lower taxable income, which defers tax. When costs are falling, FIFO produces the lower taxable income. LIFO also requires reporting that same lower profit to lenders and shareholders under the conformity requirement, so the tax benefit is not free.
Why is LIFO not allowed under IFRS? IFRS prohibits LIFO because, in a rising-cost environment, it leaves ending inventory carried at old costs that can drift far from current replacement value, which reduces the balance sheet's usefulness. LIFO remains permitted under US GAAP and the US tax code, which is why it is effectively a United States practice.
Can I switch from FIFO to LIFO or back? Not freely. Your inventory method is a method of accounting, so a change generally requires IRS consent through Form 3115, and adopting LIFO is elected on Form 970. There are computational and ongoing recordkeeping requirements either way, so treat a switch as a planned project with a CPA rather than a software setting.
About the author: Kimberly Green is the cofounder of Sam's List, where business owners and high earners find vetted CPAs, financial advisors, and fractional CFOs. She's met one-on-one with 400+ financial professionals and writes from the real data behind thousands of client-advisor matches. Ask her anything about finding an accountant - she's heard it all, including the questions people are afraid to ask.