FIFO Vs LIFO: The Basics on These Two Inventory Valuation Methods
Keeping track and valuating your inventory is a must for any company.
In the US, we value inventory both at the beginning and end of the year. To do this, companies mainly use either the FIFO method (first in, first out) or the LIFO method (last in, first out). Each method has different implications for your company, so today we will compare the two to see how they may affect your company.
When using FIFO, the oldest items in your inventory are sold first. Because of this, when reporting with FIFO, your inventory is valued at a lower cost due to the age of the inventory being reported with this method. Since the costs are lower, your taxes will also be higher. Another important thing to take note of is that many international countries who use IFRS for their accounting standards, only allow FIFO to be used.
LIFO is the opposite of FIFO, the newer items in your inventory are sold first. Keeping up with this opposite theme, because your inventory is valued at a higher cost, then your taxes will be considerably lower, since newer inventory is generally more expensive. Because of lower taxes, the IRS does not prefer LIFO, but you can still use LIFO in the US. To do this, you have to get permission from the IRS.
Based on this basic information on the two methods, you may be wondering which is the best to use. Obviously you should consult a tax advisor to determine the best one for your company, but if we were to look at the two methods theoretically or in a “general sense,” then FIFO would be the best method. The main reason being is because FIFO is the only method allowed in countries using IFRS, which is a huge chunk of the world. For businesses with operations in both the US and foreign countries, it is crucial to use FIFO. Again, this is a theoretical answer not tax advice. If you want the right method for your company, you need to consult a tax advisor.