Conceptual Foundation

• FIFO (First In, First Out): This method operates on the principle that the first goods purchased or produced are the first to be sold or used. It mirrors the natural flow of inventory and is intuitive in tracking the cost of goods sold (COGS).
• LIFO (Last In, First Out): Conversely, LIFO assumes that the most recently acquired or produced goods are the first to be sold or used. This method may better reflect the current costs of inventory during inflation but can complicate inventory management.

Financial Impact

• FIFO: Typically results in higher reported profits during inflationary periods because older, lower-cost inventory is used to calculate COGS, leaving newer, higher-cost inventory in ending inventory.
• LIFO: Often leads to lower taxable income during inflationary periods due to higher COGS (from newer, more expensive inventory), thereby reducing taxable profit.

Cost of Goods Sold (COGS)

• FIFO: Generally results in a lower COGS when prices are rising because older, cheaper inventory is sold first.
• LIFO: Tends to yield a higher COGS under inflation as newer, costlier inventory is used first.

Balance Sheet Presentation

• FIFO: Typically results in higher inventory valuation on the balance sheet because the latest, more expensive inventory remains in stock.
• LIFO: Often shows a lower inventory valuation on the balance sheet since older, cheaper inventory is assumed to be sold first.

Complexity

• FIFO: Generally simpler to implement and understand, making it more suitable for small businesses or those with straightforward inventory flows.
• LIFO: Can be more complex due to the need for detailed record-keeping and adjustments, especially in periods of fluctuating prices.

Tax Implications

• FIFO: May lead to higher taxable income in inflationary periods since lower COGS results in higher profits.
• LIFO: Often results in lower taxable income due to higher COGS, potentially reducing tax liabilities.

International Financial Reporting Standards (IFRS) vs. Generally Accepted Accounting Principles (GAAP)

• FIFO: Acceptable under both IFRS and GAAP, though its use may vary depending on jurisdiction and industry norms.
• LIFO: Generally accepted under GAAP but prohibited under IFRS, potentially influencing multinational companies’ financial reporting.

Inventory Management

• FIFO: Encourages turnover of older inventory, reducing the risk of obsolescence and spoilage.
• LIFO: Can lead to a buildup of older inventory, potentially increasing storage costs and risks.

Strategic Considerations

• FIFO: Suitable for industries with stable or falling prices, as it prevents inventory from being overvalued.
• LIFO: Benefits industries prone to inflation, as it reflects current costs more accurately.

Industry Preferences

• FIFO: Commonly favored in industries such as retail and food where perishability and turnover are critical.
• LIFO: Often preferred in industries like manufacturing and automotive, where raw material costs fluctuate significantly.