Lessons · Accounting · inventory: FIFO and LIFO
FIFO and LIFO: which cost leaves first
When identical units were bought at different prices, the books need a rule for which cost goes out with each sale. FIFO -- first in, first out -- takes the oldest cost first; LIFO, last in, first out, takes the newest. The rule changes cost of goods sold and what is left in inventory, not what is on the shelf. Whether LIFO is yours to choose depends on the standard your books are kept under: the international standard permits FIFO and weighted average and does not permit LIFO, while United States rules do permit it.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
Prices rose during the year and the owner asks why profit fell when sales did not. Under LIFO the newest, dearest cost went out with every sale. Same shop, same sales, same stock: a different rule and a different profit. And it is worth knowing which of the two you may actually use before an interview asks: outside the United States, LIFO is usually not on the table at all.
How to think about it
List the purchases in order with quantity and unit cost. For FIFO, take the units sold from the top of the list; for LIFO, from the bottom. Add up what you took. What you did not take is ending inventory, and the two must add back to the total cost.
Worked example
Bought 10 at 5 = 50, then 10 at 7 = 70; total 120 for 20 units; sold 12Two layers of cost, one sale.
FIFO cost of goods sold = 10 × 5 + 2 × 7 = 50 + 14 = 64The oldest ten at 5 go first, then two from the newer layer.
LIFO cost of goods sold = 10 × 7 + 2 × 5 = 70 + 10 = 80The newest ten at 7 go first, then two from the older layer.
Ending inventory: FIFO 120 − 64 = 56 (8 × 7); LIFO 120 − 80 = 40 (8 × 5)What was not sold. Either way, sold plus left equals what was bought.
Your turn
Ten at 6, then ten at 9, thirteen sold. Write the FIFO line with the second cost filled in.
FIFO cost of goods sold = 10 × 6 + 3 × = 87
Solve one, graded on the server
The trap
Thinking FIFO describes which physical box left the warehouse. It describes which cost left the books. The warehouse can hand out any box it likes. The other trap is assuming both methods are available wherever you are: learn the arithmetic of both, because an examination will ask for both, but check which one your own books may use before you propose a change to them.