FIFO vs LIFO: What’s the Difference?
If your business manages inventory, you’ll need to implement an inventory accounting system. Inventory accounting systems are used to determine the cost of goods sold (COGS) and the value of inventory. There’s first in, first out (FIFO), and there’s last in, first out (LIFO). What’s the difference between these two inventory accounting systems, and which one should you use for your business?
What Is FIFO?
FIFO is an inventory accounting system that assumes the first products purchased from a vendor or manufacturer are the first products sold. With FIFO, you use the cost of the oldest products in your business’s inventory to calculate COGS, and you use the cost of the newest products to calculate the value of your business’s ending inventory. The FIFO accounting system is commonly used when a business wants to report a higher net income, as it results in a lower COGS and higher ending inventory value.
What Is LIFO?
LIFO is an inventory accounting system that assumes the last products purchased from a vendor or manufacturer are the first products sold. The cost of the newest products in your business’s inventory are used to calculate COGS. Conversely, the cost of the oldest products are used to calculate the value of your business’s ending inventory. The FIFO accounting system is often used when a business wants to minimize taxes, as it typically results in a higher COGS and lower ending inventory value.
Differences Between FIFO and LIFO
Two of the most common inventory accounting systems are LIFO and FIFO. While used for similar purposes, though, they aren’t the same. FIFO uses the oldest inventory products or items to calculate COSTS, whereas LIFo uses the newest inventory products or items to calculate COGS. And FIFO uses the newest inventory products or items to calculate the value of ending inventory, whereas LIFO uses the oldest inventory products or items to calculate the value of ending inventory.
There are tax implications associated with FIFO and LIFO. Because LIFO can result in a lower net income, it can result in lower taxes. Not all businesses, however, are allowed to use LIFO for tax purposes, and some countries may prohibit the use of LIFO altogether. Under the Generally Accepted Accounting Principles (GAAP), for instance, only LIFO is allowed. If your business uses the GAAP, you should choose LIFO.
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