FIFO or LIFO?

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.

👉 Answer:

👨‍🎓 Here's how we arrived at the answer:

• Taxes increase as profit increases. One way to reduce taxes is to reduce the net profit in a firm's financials. This can be done by ensuring that the highest inventory costs are recognized first. For most firms, the price of inventory is constantly increasing, so using LIFO would yield the smallest profits.
  PROFIT = CUSTOMER PAYMENT - INVENTORY AND OTHER COSTS