FIFO and LIFO are two methods of deciding which cost applies when you sell a unit of stock. They answer a question that only becomes awkward when prices change: if you bought the same product twice at different prices, which price do you use when one of them sells?
The confusion around these two comes from a single point that often goes unstated. FIFO and LIFO are accounting methods, not picking instructions. You can operate a warehouse that physically rotates oldest stock first whilst costing it under LIFO, and you can operate LIFO physically — a gravel pile is loaded from the top — whilst costing under FIFO. The physical flow and the cost flow are separate decisions.
The core difference
FIFO — First In, First Out. The cost of the oldest stock is assigned to what you sell. Your remaining inventory is valued at the most recent purchase prices. There is a full guide to the method at what is FIFO.
LIFO — Last In, First Out. The cost of the newest stock is assigned to what you sell. Your remaining inventory is valued at older prices. Likewise, what is LIFO covers it on its own.
Nothing physically moves differently. The units are identical. What changes is which cost gets recorded against the sale, and therefore what your reported profit and your closing stock value look like.
When prices are stable, the two produce the same answer. When prices are rising — which is the normal case — they diverge, and the divergence is the entire point of the debate.
A worked example
Say you buy the same product twice, then sell 120 units:
- January: 100 units at $8 each
- March: 100 units at $10 each
Total purchased: 200 units for $1,800.
Under FIFO, you cost the oldest first: 100 units at $8 ($800), then 20 units at $10 ($200). Cost of goods sold is $1,000. Your remaining 80 units are all from the March batch, valued at $10 each, so closing inventory is $800.
Under LIFO, you cost the newest first: 100 units at $10 ($1,000), then 20 units at $8 ($160). Cost of goods sold is $1,160. Your remaining 80 units are from the January batch at $8 each, so closing inventory is $640.
Same 120 units sold. Same physical stock left on the shelf. A $160 difference in reported cost of goods sold, and a $160 difference in the value of what remains.
If you sold those 120 units for $15 each — $1,800 of revenue — FIFO reports a gross profit of $800 and LIFO reports $640. FIFO looks more profitable. LIFO reports lower profit, which in a jurisdiction that permits it means lower tax.
That is the whole argument in one example: in a rising market, FIFO flatters profit and LIFO reduces tax.
Side by side
- Cost of goods sold (rising prices). FIFO lower, LIFO higher.
- Reported profit (rising prices). FIFO higher, LIFO lower.
- Tax (rising prices). FIFO higher, LIFO lower.
- Closing inventory value. FIFO reflects recent prices and is closer to replacement cost. LIFO holds old costs and can drift badly out of date.
- Balance sheet realism. FIFO better. LIFO inventory values can be decades old in a long-established business.
- Profit realism. LIFO arguably better, because it matches current costs against current revenue.
- Permitted internationally? FIFO yes. LIFO no — see below.
- Physical rotation. FIFO matches how perishable goods must be handled. LIFO rarely matches anything except bulk piles.
The big catch: LIFO isn’t allowed everywhere
This is the point that settles the decision for most businesses, and it is worth stating plainly.
LIFO is prohibited under IFRS, the accounting standard used across most of the world. It is permitted under US GAAP. So if you report under IFRS — which covers the great majority of countries — LIFO is not available to you, and the comparison is academic.
In the United States, LIFO remains legal but carries a significant condition known as the LIFO conformity rule: if you use LIFO for tax purposes, you must also use it in your financial statements. You cannot report high profits to shareholders and low profits to the tax authority. That trade-off is why many US businesses eligible for LIFO still choose FIFO.
There is also a practical trap called LIFO liquidation. If you sell more than you buy in a period, LIFO forces you to dip into old, cheap cost layers. Cost of goods sold falls sharply, profit spikes, and you get an unexpectedly large tax bill in a year when you were probably running stock down because trading was difficult.
Why would anyone choose LIFO?
Where it is permitted, the arguments are real:
- Tax deferral in an inflationary period. Higher recorded costs mean lower taxable profit and improved cash flow. This is the main reason, and for a large stockholder in a high-inflation period it can be substantial.
- Better cost matching. Charging current costs against current revenue gives a more honest picture of whether you are making money at today’s prices, rather than benefiting on paper from cheap stock bought a year ago.
- Smoother margins in a volatile market. Reported margin tracks current replacement cost more closely.
Against that: your balance sheet inventory value becomes increasingly unrealistic, comparison with IFRS-reporting competitors becomes difficult, the record-keeping is more complex, and you are locked in — switching away from LIFO requires tax authority consent and can trigger a large one-off charge.
Which should you use?
For most businesses the decision is made externally.
If you report under IFRS, use FIFO. LIFO is not permitted. Weighted average cost is the other option available to you, and it is often simpler where stock is homogeneous and prices move gently.
If you report under US GAAP, it is a genuine choice, and it is a finance decision rather than a warehouse one. Model both against your actual purchase history. If prices are rising consistently and you hold significant stock, LIFO’s tax deferral may be worth the conformity constraint. If you want a clean balance sheet, comparability, or you are seeking investment, FIFO is usually the easier answer.
If your goods are perishable or dated, physically rotate oldest first regardless of which costing method you use. That is a stock control requirement driven by expiry and obsolescence, not an accounting one, and it applies whatever your accountant has chosen.
How the choice shows up in your warehouse
Although this is an accounting decision, it leaves fingerprints on daily operations.
Stock rotation discipline. If you cost under FIFO and your team picks whatever is nearest, your books and your shelves gradually tell different stories. For non-perishable goods that discrepancy is only a valuation question. For dated goods it becomes write-offs. Location design matters more than instruction here — flow racking that loads at the back and picks at the front enforces rotation without anyone having to remember.
Batch and date capture at receiving. Neither method works properly if you do not record what arrived, when, and at what cost. Operations that book stock in as a single undifferentiated quantity cannot apply any costing method accurately, and the resulting figures are estimates wearing the costume of precision.
Cycle counting. Counting by location rather than by SKU total is what surfaces rotation failures. A SKU can reconcile perfectly in total whilst the oldest units sit untouched at the back of a bay.
System configuration. Most WMS and ERP platforms hold a costing method per item or per warehouse, set during implementation and rarely revisited. It is worth confirming that what the system is doing matches what your accounts assume. Mismatches between the two are common and usually discovered during an audit.
Write-off visibility. Under FIFO, ageing stock carries older costs, so writing it off produces a smaller hit than its replacement cost implies. That can make obsolescence look cheaper than it is. A separate ageing report, independent of valuation, keeps the real picture visible.
A second example: falling prices
The rising-price case gets all the attention, so it is worth seeing the reverse, because the conclusions flip.
Using the same structure but with prices falling — 100 units bought in January at $10, then 100 in March at $8, and 120 sold:
- FIFO: 100 at $10 ($1,000) + 20 at $8 ($160) = $1,160 cost of goods sold. Closing stock 80 units at $8 = $640.
- LIFO: 100 at $8 ($800) + 20 at $10 ($200) = $1,000 cost of goods sold. Closing stock 80 units at $10 = $800.
Now FIFO reports the higher cost and lower profit, and LIFO the reverse. The methods have no inherent bias — they simply track whichever direction your purchase prices are moving. Anyone describing LIFO as “the tax-efficient one” is assuming inflation, which has usually been a safe assumption but is not a property of the method.
Weighted average cost: the third option
Most comparisons treat this as a two-horse race. In practice a large share of businesses use neither, and use weighted average cost instead.
It works exactly as it sounds. Every purchase goes into a pool, and the cost applied to a sale is the running average of everything in that pool. Using the earlier figures — 100 units at $8 and 100 at $10 — the average cost is $9 per unit. Selling 120 units gives a cost of goods sold of $1,080, sitting neatly between the FIFO figure of $1,000 and the LIFO figure of $1,160. Closing stock is 80 units at $9, or $720.
Its merits are practical rather than theoretical:
- Simplicity. No cost layers to track. One number per item, recalculated on each receipt.
- Smoothing. A single expensive purchase does not distort the next few sales.
- Permitted everywhere. Acceptable under both IFRS and US GAAP.
- Suits homogeneous stock. Where units genuinely are interchangeable — fasteners, chemicals, fuel — tracking layers is effort without insight.
Its weakness is that it reflects neither current replacement cost nor original cost, so in a period of sharp price movement it is slightly wrong in both directions at once. For most businesses that is an acceptable trade for the reduction in administration.
If you are choosing a method for a new operation reporting under IFRS, the real decision is usually FIFO against weighted average, not FIFO against LIFO.
Where to go deeper
- What is FIFO — the method on its own, including physical rotation in a warehouse.
- What is LIFO — the same for LIFO, including the liquidation trap.
- Inventory valuation methods — FIFO, LIFO, weighted average and specific identification compared.
- Carrying cost of inventory — what holding that stock costs you regardless of how it is valued.
- Inventory turnover — how fast it moves, which affects how much the costing choice matters.
The one-line takeaway
FIFO costs the oldest stock first and LIFO the newest; in a rising market FIFO reports higher profit and LIFO lowers tax — but LIFO is banned under IFRS, so for most of the world the choice is already made.
Frequently asked questions
Is FIFO or LIFO better? Neither is better in principle. FIFO gives a more realistic balance sheet and is permitted everywhere. LIFO can defer tax in an inflationary period but is only available under US GAAP. For most businesses the reporting standard decides it.
Is LIFO banned? It is prohibited under IFRS, which is used in most countries. It remains permitted under US GAAP, subject to the conformity rule requiring you to use it in financial statements as well as for tax.
Does FIFO mean I have to pick the oldest stock first? No. FIFO as an accounting method concerns which cost you assign, not which box you pick. You should still physically rotate perishable or dated goods oldest-first, but that is a stock control decision made for its own reasons.
What happens to FIFO and LIFO when prices fall? The effects reverse. With falling prices, LIFO produces a lower cost of goods sold and higher reported profit, and FIFO the opposite.
What is the alternative to FIFO and LIFO? Weighted average cost, which blends all purchase costs into a single average applied to every unit sold. It is simpler to run and smooths price fluctuations, and it is permitted under both IFRS and US GAAP. Specific identification — tracking the actual cost of each individual unit — is used for high-value, serialised goods such as vehicles and jewellery.
Can I switch from LIFO to FIFO? In the US this generally requires tax authority approval and can trigger a substantial one-off tax charge as deferred LIFO reserves unwind. It is not a decision to take without advice.
Does the method affect how much tax I pay overall? Over the entire life of a business, no — the same costs pass through eventually. What changes is timing. LIFO in an inflationary period defers tax into later years, which improves cash flow now. That deferral can reverse sharply if stock levels fall.
Which method do most businesses use? FIFO, by a wide margin. It is the only one of the two permitted internationally, it matches how perishable goods must be physically handled anyway, and it produces a closing stock value close enough to replacement cost that the balance sheet stays meaningful. Weighted average is the common second choice, particularly where units are genuinely interchangeable.
Warehouse Wise is a free, independent library of guides on inventory management, warehousing and fulfilment, written for the people actually doing the work — new warehouse and inventory staff, small and growing retail and ecommerce businesses, and anyone who holds stock and wants to understand it properly. Every guide explains the term, shows a worked example with real numbers where it helps, and stops. We are independent: we do not sell software or equipment, we take no commission on referrals, and our guides are not ranked by who pays us.