FIFO vs LIFO: the great business accounting debate.
At the end of your fiscal year, you’ll probably use one of these two accounting methods to value your inventory and report your profitability.
But they’re distinctly different and will produce very different results on your balance sheet.
To help you understand their differences, we’ll look at the advantages and disadvantages of LIFO and FIFO and give you our opinion on which one you should use in your business.
But before we do that, let’s define FIFO and LIFO.
What are FIFO and LIFO?
To determine your cost of goods sold at the end of the fiscal year, you need to determine the cost of all the products in your inventory.
That’s where FIFO and LIFO come in. Here’s what they stand for:
What is FIFO?
FIFO (first in, first out) is an inventory accounting method that says the first items in your inventory are the first ones that leave – meaning you get rid of your oldest inventory first.
What is LIFO?
LIFO (last in, first out) is an inventory accounting method that says the last items in your inventory are the first ones that leave – meaning you get rid of the newest inventory first.
FIFO vs LIFO: Advantages and Disadvantages
FIFO and LIFO are exact opposite accounting methods that deliver dramatically different results. Before you implement either of them, you should know the primary benefits and drawbacks of each method, which we detail below.
Primary Benefits of FIFO
- FIFO is the most common accounting method.
- There are no GAAP or IFRS restrictions on the use of FIFO.
- FIFO increases the value of your inventory during inflation because your older items with a lower cost of goods are now a smaller percentage of your sales.
- There’s less record-keeping since the oldest items in your inventory are continually used up.
- If costs are decreasing, you pay fewer income taxes in the near-term since the first items sold are the most expensive.
Primary Drawback of FIFO
- If costs are increasing, you pay a larger amount of income taxes in the near-term since the first items sold are the least expensive.
Primary Benefit of LIFO
- If costs are increasing, you pay fewer income taxes in the near-term since the last items sold are the most expensive and you report the fewest profits.
Primary Drawbacks of LIFO
- If costs are decreasing, you pay a larger amount of income taxes in the near-term because the last items sold are the least expensive which lowers your cost of goods sold leading to a report of higher profits.
- The IFRS doesn’t allow the use of the LIFO method.
- LIFO increases your layers of record-keeping since the oldest layers could remain in your system for years.
FIFO vs LIFO: Which Should You Use?
Well, there are obviously more benefits to using FIFO than LIFO, especially in the food industry.
If you handle food inventory management or operate any business with perishable items, then you pretty much have to use FIFO. Otherwise, you’ll end up with obsolete inventory that you’ll have to write-off as a loss.
With that said, LIFO is a great method for non-perishable homogeneous goods like stone or brick. So, if you get a fresh batch of items like these, you don’t need to rearrange your warehouse or rotate batches since they’ll be the first ones out anyway.
The bottom line:
Most businesses will benefit from FIFO while a select few businesses in specific industries will be better off using LIFO.
Regardless of which method you choose, you’ll need a powerful inventory management software that can automatically calculate your cost of goods sold in real-time.
And you probably want a software that automatically tracks fluctuations in prices for POs and suppliers, and helps you get the best deal on your goods.
Where can you find an inventory management software that delivers accurate reporting and so much more?
Right here at DEAR Inventory.
Use DEAR to Make Accounting Easier with FIFO
DEAR seamlessly Integrates with top-of-the-line accounting apps like Xero and Quickbooks, it syncs all of your invoices, bills, and payments to an app that can be accessed anywhere, and is built for true cost calculations and the FIFO method of accounting. We’ll give you financial data in real-time for smarter decision-making and higher profits.
Start your free 14-day trial of DEAR Inventory today!
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