Inventory: FIFO vs. LIFO and Why It Matters — Financial Accounting

§ 01

Method	In Rising Prices	Tax Effect	Cash Flow Effect
FIFO (First In, First Out)	Lower COGS, higher profit	Higher taxes	Lower cash (more tax paid)
LIFO (Last In, First Out)	Higher COGS, lower profit	Lower taxes	Higher cash (less tax paid)
Weighted Average	Middle ground	Moderate	Moderate

§ 02

LIFO is only allowed under US GAAP, not IFRS. This is one reason comparing US and international companies requires careful adjustment.

§ 03

In an inflationary environment, which method reports the HIGHEST net income?

§ 04

LIFO reduces taxes but also reduces reported earnings. Analysts often adjust LIFO companies to FIFO for comparability using the LIFO Reserve disclosed in footnotes.

§ 05

In an inflationary environment, Company A uses FIFO inventory, Company B uses LIFO. Both have identical sales and operations. Who reports higher earnings and why?

§ 06

Going Deeper — the LIFO reserve as a comparability bridge. When peers use FIFO and the company uses LIFO, restate to FIFO before comparing margins, ROIC, or inventory turns. The formulas: FIFO Inventory = LIFO Inventory + LIFO Reserve; FIFO COGS = LIFO COGS − Δ LIFO Reserve. Apply this lens whenever you screen US industrials against international peers (IFRS bans LIFO, so non-US peers are FIFO by default). AI prompt: "Pull this company's LIFO reserve from the latest 10-K and tell me what its inventory and gross profit would look like under FIFO. By what percentage is reported inventory understated?"

Five questions · AI feedback

Sit with the ideas.

A company uses LIFO. Its LIFO inventory is $100,000 and the LIFO Reserve is $30,000. LIFO COGS is $500,000 and the change in LIFO Reserve this year was +$10,000. What would inventory and COGS be under FIFO?

Why:

Sit with the ideas.

Other lessons in this course.