How to Calculate LIFO and FIFO: Accounting Methods for Determining COGS Cost of Goods Sold

The FIFO method assumes that the oldest inventory units are sold first, while the LIFO method assumes that the most recent inventory units are sold first. LIFO better matches current costs with revenue and provides a hedge against inflation. Finally, weighted average cost provides a clearer position of the costs of goods sold, as it takes into account all of the inventory units available for sale. Cin7 provides advanced automation processes to create seamless transactions centered around a positive customer experience.

As a result, the company would record lower profits or net income for the period. However, the reduced profit or earnings means the company would benefit from a lower tax liability. The LIFO reserve is the difference between the inventory reported under LIFO and what it would have been using FIFO. This reserve represents the amount by which a company’s taxable income has how to calculate fifo and lifo been deferred by using the LIFO method.

How to use the FIFO method

This results in lower taxable income, reducing the amount a company owes in taxes. The key characteristic of LIFO is that it aligns current costs with current revenues, meaning that in times of rising prices, the COGS will be higher, resulting in lower taxable income. Let’s assume that Sterling sells all of the units at $80 per unit, for a total revenue of $20,000.

She has more than five years of experience working with non-profit organizations in a finance capacity. Keep up with Michelle’s CPA career — and ultramarathoning endeavors — on LinkedIn. Learn more about what LIFO is and its impact on net income to decide if LIFO valuation is right for you. It’s especially useful if you deal with stock rotation based on expiration dates – for instance, grocery stores and restaurants need to sell the oldest food first so it doesn’t spoil. FIFO is a useful method in retail, manufacturing, warehouse operations, or any other industry that tracks inventory.

What Does YTD Gross Mean on Your Pay Stub?

FIFO states that if the bakery sold 200 loaves on Wednesday, the COGS (on the income statement) is $1 per loaf because that was the cost of each of the first loaves in inventory. The $1.25 loaves would be allocated to ending inventory (on the balance sheet). Since inventory moves among different stages in your organization, it’s challenging to track all the costs of individual items. Therefore, it is important that serious investors understand how to assess the inventory line item when comparing companies across industries or in their own portfolios. The same example used earlier can be used to show the LIFO method for calculating the cost of goods sold (COGS).

• Ending inventory represents the value of unsold inventory remaining at period end and is reported as a current asset on the balance sheet.
• Inventory costing is made more precise through these calculators, allowing you to focus on optimizing operations rather than getting bogged down in complex manual calculations.
• Using the previous example, FIFO yielded COGS of $2,200 and ending inventory of $1,800.
• To calculate Cost of Goods Sold (COGS) using LIFO, identify the number of units sold and assign costs starting from the most recent inventory.
• Accounting for inventory is essential—and proper inventory management helps you increase profits, leverage technology to work more productively, and reduce the risk of error.

Future Trends in Inventory Accounting

It increases net profit in inflationary periods because older, cheaper inventory is used first. By the end, you will have a clear understanding of inventory valuation and a better insight into how inventory management software simplifies the management of FIFO and LIFO. Below, we’ll break down the formulas for FIFO and LIFO, along with how to calculate the value of the remaining inventory under each method. This method ensures that products with shorter shelf lives—such as skincare, hair care, and hygiene products—move efficiently while maintaining accurate inventory valuation.

• This method often reflects the physical flow of inventory for many businesses, especially those dealing with perishable goods.
• In the USA, companies prefer to use LIFO because it can help them reduce their taxable income.
• Choosing between FIFO and LIFO depends on several factors, including economic conditions, tax considerations, and business goals.
• All pros and cons listed below assume the company is operating in an inflationary period of rising prices.
• Because FIFO results in a lower recorded cost per unit, it also records a higher level of pretax earnings.

Also, by matching lower-cost inventory with revenue, the FIFO method can minimize a business’s tax liability when prices are declining. Explore LIFO and FIFO methods and their distinct effects on financial reporting. LIFO typically results in higher COGS and lower taxable income during inflation, potentially reducing tax liabilities. It’s important to consider that LIFO is not permitted under International Financial Reporting Standards (IFRS), limiting its use for companies operating internationally. The choice between FIFO and LIFO impacts financial statements, tax obligations, and overall business strategy.

This method ensures inventory on the balance sheet reflects costs closest to current market prices, as it assumes latest purchases are still on hand. Under the FIFO method, sales for the period are multiplied by the cost of items that entered inventory the earliest to calculate COGS. When it comes to inventory, chances are you know what you have in stock—but do you know its true value? Tracking your company’s inventory is only part of effective inventory management.

Most businesses use either FIFO or LIFO, and sole proprietors typically use average cost. The last in, first out (LIFO) accounting method assumes that the latest items bought are the first items to be sold. With this accounting technique, the costs of the oldest products will be reported as inventory. It should be understood that, although LIFO matches the most recent costs with sales on the income statement, the flow of costs does not necessarily have to match the flow of the physical units.

Consequently, a lower COGS leads to a higher reported gross profit and net income. The ending inventory balance under FIFO will reflect the more recent, higher costs, resulting in a higher inventory value on the balance sheet. Choosing between FIFO and LIFO depends on several factors, including economic conditions, tax considerations, and business goals. FIFO may be preferable for businesses seeking to maintain an accurate reflection of current inventory costs and higher profitability during inflation. LIFO might be more suitable for those looking to minimize taxable income in inflationary periods. When comparing FIFO vs LIFO accounting, the primary difference lies in how each method impacts financial statements.

Learn differences between FIFO vs. LIFO, and how to calculate FIFO and LIFO step by step. Optimize inventory valuation, cut costs, and improve your business’s financial accuracy. FIFO helps minimize spoilage, waste, and quality issues, making it the standard choice for inventory management and financial reporting in the Food and Beverage sector.

Using FIFO and LIFO calculators simplifies this process by automating calculations based on your chosen inventory valuation method. With these tools, you effortlessly track inventory turnover and maintain effective control over stock levels. This subtle shift can have tangible effects on reported earnings and tax liabilities due to differing valuation methods. Inventory costing is made more precise through these calculators, allowing you to focus on optimizing operations rather than getting bogged down in complex manual calculations.