FIFO vs LIFO and its Effect on Gross Profit
FIFO vs LIFO Example
By way of illustration, the following example explains the different outcomes when considering FIFO vs LIFO.
If a business had the following inventory information for August:
- August 1 Beginning inventory 100 units @ 3.00 cost per unit
- August 4 Purchased 400 units @ 2.50 cost per unit
- August 24 Purchased 300 units @ 6.00 cost per unit
- August 31 Sold 200 units
If the units were sold for 10.00 each, calculate the gross profit.
To compare FIFO vs LIFO we first look at the FIFO method. Using FIFO the first items into inventory are the first items to be sold.
|Sell||– 100||– 100||– 200|
This table converts the units in the table above to cost at either 3.00, 2.50 or 6.00 per unit.
|Sell||– 300||– 250||– 550|
Using FIFO, the ending inventory is valued at 2,550 and cost of goods sold is 550. If the units sell for 10.00 each then the gross profit is calculated as follows:
Gross profit = Revenue - COGS Gross profit = 200 x 10.00 - 550 Gross profit = 1,450
The second method in our FIFO vs LIFO comparison is LIFO. In the LIFO method the last items into inventory are the first items to be sold.
Using the same values with the LIFO method we get the following result:
|Sell||– 200||– 200|
This table converts the units in the table above to values at either 3.00, 2.50 or 6.00 per unit.
|Sell||– 1,200||– 1,200|
Using LIFO, the ending inventory is valued at 1,900 and cost of goods sold is 1,200.
If the units sell for 10.00 each then the gross profit is calculated as follows:
Gross profit = Revenue - COGS Gross profit = 200 x 10.00 - 1,200 Gross profit = 800
FIFO vs LIFO Comparison of Gross Profit
The FIFO versus LIFO comparison shows that the gross profit using LIFO (800) is lower than the gross profit using FIFO (1,450). This is summarized in the table below.
The cost of goods sold in LIFO is normally higher than in FIFO as it is valued using the last items into inventory which, in times of rising prices, tend to be the highest valued items.
FIFO vs LIFO Comparison Cost Allocation
Note that the cost of goods sold plus the ending inventory is the same in each case. It’s only the split between the two items which changes.
FIFO vs LIFO Comparison – Rising and Falling Prices
The effect of rising and falling prices on gross profit, cost of goods sold and ending inventory of using FIFO or LIFO is summarized in the tables below.
In each case the table shows the method which gives the highest value, for example in times of rising prices FIFO will give the highest gross profit.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.