Guides
FIFO vs LIFO: Inventory Costing Methods Compared
FIFO vs LIFO describes two ways to assign cost to the inventory a business sells. FIFO (First In, First Out) expenses the oldest costs first. LIFO (Last In, First Out) expenses the newest costs first. The choice does not change what physically moves off the shelf. It changes which costs land in cost of goods sold, which reshapes reported gross profit, net income, and, for U.S. tax filers, the tax bill.
The two methods only diverge when unit costs change. When prices rise, LIFO pushes higher recent costs into cost of goods sold and leaves older, cheaper costs on the balance sheet. FIFO does the reverse. In stable prices the two produce identical numbers.
FIFO vs LIFO at a glance
FIFO assigns the earliest purchase costs to units sold and reports the most recent costs as ending inventory. LIFO assigns the most recent purchase costs to units sold and reports the oldest costs as ending inventory. FIFO is permitted under both U.S. GAAP and IFRS. LIFO is permitted under U.S. GAAP but prohibited under IFRS, which limits its use to certain U.S. filers.
| Factor | FIFO (First In, First Out) | LIFO (Last In, First Out) |
|---|---|---|
| Cost assigned to COGS | Oldest purchase costs | Newest purchase costs |
| Ending inventory value | Most recent costs | Oldest costs |
| COGS when prices rise | Lower | Higher |
| Net income when prices rise | Higher | Lower |
| Income tax when prices rise | Higher | Lower |
| Balance sheet inventory when prices rise | Closer to current cost | Can be badly understated |
| U.S. GAAP | Allowed | Allowed |
| IFRS (IAS 2) | Allowed | Prohibited |
| Physical flow match | Matches most perishable goods | Rarely matches physical flow |
How FIFO and LIFO change COGS and net income during inflation
During inflation the two methods split apart. LIFO moves newer, higher costs into cost of goods sold, so COGS rises and pre-tax income falls. FIFO moves older, lower costs into COGS, so COGS is lower and pre-tax income is higher. Lower income under LIFO can mean a smaller current tax bill, which is the main reason U.S. companies elect it.
A short worked example makes the split concrete. Suppose a company buys three identical units: one at $10, one at $12, and one at $14, then sells one unit for $20.
- Under FIFO, COGS is $10 (the oldest cost). Gross profit is $10. Ending inventory is $26 ($12 plus $14).
- Under LIFO, COGS is $14 (the newest cost). Gross profit is $6. Ending inventory is $22 ($10 plus $12).
Same sale, same cash, different reported profit. FIFO reports $4 more gross profit here, which raises taxable income and the tax due. LIFO reports less profit and defers tax, but it leaves ending inventory carried at older, lower costs. Over many periods this gap is tracked as the LIFO reserve, the difference between inventory valued under FIFO and under LIFO.
When prices fall, the results flip. LIFO then produces lower COGS and higher income, and FIFO produces the opposite. The benefit of LIFO depends on sustained rising costs and stable or growing inventory quantities. Shrinking inventory can trigger LIFO liquidation, where old low costs flow into COGS and inflate income in a single year.
Why LIFO is not allowed under IFRS
LIFO is banned under IFRS. IAS 2, the international standard on inventories, permits FIFO and weighted average cost but does not allow LIFO for any reporting period. The stated concern is that LIFO can leave inventory on the balance sheet at costs from years or decades ago, which may not reflect a reasonably current value and can distort comparisons between companies.
This creates a practical divide. U.S. GAAP still allows LIFO, so it remains available to U.S. filers. Companies reporting under IFRS, common outside the United States, cannot use it at all. A U.S. parent with foreign subsidiaries that report under IFRS has to manage this split carefully, because the tax rules described below can tie the two together.
The LIFO conformity rule
The LIFO conformity rule is a U.S. tax requirement in IRC Section 472. It says that if a taxpayer uses LIFO to figure taxable income, it must also use LIFO in the financial statements it issues to shareholders, creditors, and other outside users. A company generally cannot claim LIFO’s lower taxable income on the return while reporting higher FIFO income to lenders or investors.
The rule exists to stop taxpayers from having it both ways. Without it, a business could report low income to the IRS under LIFO and high income to a bank under FIFO in the same year. Violating conformity can cause the IRS to terminate the LIFO election, which can pull the deferred LIFO reserve back into taxable income.
To elect LIFO, a taxpayer files Form 970, Application to Use LIFO Inventory Method, attached to the return for the first year of the election. Many businesses use a dollar-value LIFO method under Treasury regulations, and certain small businesses may use a simplified dollar-value method under IRC Section 474. Once adopted, LIFO generally must continue unless the IRS consents to a change.
The conformity rule also connects directly to IFRS. Because IFRS prohibits LIFO, a U.S. company that switches its primary financial statements to IFRS can no longer satisfy conformity, which would force it off LIFO for tax as well. This linkage is one reason a broad U.S. move to IFRS has stalled, since it could accelerate large deferred LIFO reserves into taxable income for many companies.
Which method should a business choose
There is no single right answer. FIFO tends to fit businesses with perishable or fast-moving goods, produces a balance sheet closer to current cost, and is required for anyone reporting under IFRS. LIFO can defer U.S. income tax when costs are rising and quantities are stable, but it adds complexity, can understate inventory, and locks the company into the conformity rule.
Practical factors that often drive the decision:
- Reporting framework. IFRS filers must use FIFO or weighted average. LIFO is off the table.
- Price trend. LIFO’s tax benefit depends on sustained rising costs. Flat or falling costs erase it.
- Inventory stability. Falling inventory levels can trigger LIFO liquidation and a tax spike.
- Stakeholder optics. LIFO lowers reported earnings, which can affect loan covenants and valuation multiples.
- Administrative cost. LIFO pools, the LIFO reserve, and Form 970 add ongoing compliance work.
A tax advisor can model both methods against the company’s actual purchase history and expected price trend before an election is filed, since the choice is hard to reverse without IRS consent.
Frequently asked questions
What is the main difference between FIFO and LIFO?
FIFO expenses the oldest inventory costs first, leaving recent costs on the balance sheet. LIFO expenses the newest costs first, leaving older costs in ending inventory. The physical goods sold do not change. Only the cost assigned to those goods changes, which affects cost of goods sold, gross profit, and reported net income when unit costs rise or fall.
Does FIFO or LIFO result in higher net income during inflation?
FIFO generally produces higher net income during inflation. It assigns older, lower costs to cost of goods sold, so COGS is smaller and pre-tax profit is larger. LIFO assigns newer, higher costs to COGS, which lowers reported income. Higher FIFO income can also mean a larger current income tax bill, which is why some U.S. companies prefer LIFO.
Why is LIFO banned under IFRS?
IFRS bans LIFO through IAS 2, which permits only FIFO and weighted average cost. The standard-setter’s concern is that LIFO can leave ending inventory valued at very old costs that may not reflect a reasonably current value, reducing comparability across companies. As a result, companies reporting under IFRS cannot use LIFO, while U.S. GAAP filers still can.
What is the LIFO conformity rule?
The LIFO conformity rule, in IRC Section 472, requires a U.S. taxpayer that uses LIFO on its tax return to also use LIFO in the financial statements given to outside users. It prevents a company from reporting low LIFO income to the IRS while showing higher FIFO income to lenders or investors. Violating it can cause the IRS to terminate the LIFO election.
How does a business elect LIFO for U.S. tax purposes?
A business elects LIFO by filing Form 970, Application to Use LIFO Inventory Method, with its income tax return for the first year of the election. Many filers use a dollar-value LIFO method, and some small businesses may use the simplified method under IRC Section 474. Once elected, LIFO generally must continue unless the IRS Commissioner consents to a change.
Can a company switch from LIFO to FIFO?
A company can switch, but it usually requires IRS consent through a change in accounting method, often on Form 3115. Switching off LIFO can pull the accumulated LIFO reserve back into taxable income, sometimes over several years under a spread provision. Because the tax cost can be large, businesses generally model the effect with a tax advisor before changing methods.
For related reading, see how inventory costs flow through the cost basis of an asset, how depreciation methods create a similar timing choice for long-lived assets, how a method switch is filed on Form 3115, and how cost flow assumptions like FIFO and specific identification apply to digital assets.
Reviewed by The Ledgerism Editorial Team. Last reviewed: July 2026.