FIFO or LIFO?

Lesson:

LIFO (last in, first out) and FIFO (first in, first out) are two methods of measuring inventory value.

For many companies, it's incredibly important to know how much their inventory is worth. These inventories are assets that can be used to generate profits.

But, it's often difficult to track each and every piece of inventory. Pretend that you own a company that has an inventory of millions of plastic straws. It would be nearly impossible (and extremely expensive) to figure out what a particular straw cost to purchase.

So accountants engage in a little fiction. If they have a lot of identical goods, they will just say, "Oh, I bought a unit for $35, and I'll just pretend that the one in my hand was the one."

The question is, should they pretend that the unit that is about to be sold was one of the firm's earliest remaining purchases (LIFO) or one its most recent (FIFO)?

There are advantages to each, as you will soon see.

You're a consultant with expertise in inventory management. One of your clients needs your help to determine which method to use for tracking inventory.

Here's what you know:

  • The inventory tends to fall out of fashion in short time periods.
Which would be more advantageous, FIFO or LIFO?

Answer:

  • The firm should use FIFO.

Explanation:

    When goods are perishable, the oldest goods are usually sold first. The LIFO approach would most closely match the physical flow of goods and make accounting sense.
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