FIFO vs LIFO Comparison

FIFO vs LIFO and its Effect on Gross Profit

FIFO and LIFO are different methods used in inventory management. The method chosen (FIFO vs LIFO) will affect the valuation placed on the ending inventory and the value of cost of goods sold (COGS).

 

The difference between the FIFO and LIFO methods is summarized in the diagrams below which show the sale of two units. The number inside each unit represents its cost price.

fifo vs lifo


fifo vs lifo

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.

FIFO Method

To compare FIFO vs LIFO we first look at the the FIFO method. Using FIFO the first items into inventory are the first items to be sold.

FIFO Method Showing Units
Unit Cost 3.00 2.50 6.00 Total
Beginning 100 100
Purchase 400 300 700
Sell – 100 – 100 – 200
Ending 0 300 300 600

This table converts the units in the table above to cost at either 3.00, 2.50 or 6.00 per unit.

FIFO Method Showing Cost
Unit Cost 3.00 2.50 6.00 Total
Beginning 300 300
Purchase 1,000 1,800 2,800
Sell – 300 – 250 – 550
Ending 0 750 1,800 2,550

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 

LIFO Method

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:

LIFO Method Showing Units
Unit Cost 3.00 2.50 6.00 Total
Beginning 100 100
Purchase 400 300 700
Sell – 200 – 200
Ending 100 400 100 600

This table converts the units in the table above to values at either 3.00, 2.50  or 6.00 per unit.

LIFO Method Showing Value
Unit Cost 3.00 2.50 6.00 Total
Beginning 300 300
Purchase 1,000 1,800 2,800
Sell – 1,200 – 1,200
Ending 300 1,000 600 1,900

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 vs 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.

Comparison of FIFO vs LIFO Gross Profit
FIFO LIFO
Revenue 2,000 2,000
COGS 550 1,200
Gross profit 1,450 800

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.

Comparison of FIFO vs LIFO Cost Allocation
FIFO LIFO
Ending 2,550 1,900
COGS 550 1,200
Total 3,100 3,100

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.

Method giving highest value
Prices Inventory COGS Profit
Rising FIFO LIFO FIFO
Falling LIFO FIFO LIFO
Last modified April 6th, 2019 by Michael Brown

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 in 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 BSc from Loughborough University.

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