What is FIFO and LIFO?

When you buy the same item at different prices over time, you need a method to decide which cost goes to cost of goods sold and which remains in inventory. The IRS describes inventory methods in Publication 538.

FIFO: first in, first out

FIFO assumes the oldest items are sold first. Cost of goods sold uses older costs; ending inventory reflects the most recent costs. When prices are rising, FIFO generally produces lower cost of goods sold and higher profit.

LIFO: last in, first out

LIFO assumes the newest items are sold first. Cost of goods sold uses recent costs; ending inventory reflects older costs. When prices are rising, LIFO generally produces higher cost of goods sold, lower taxable income and lower inventory values. LIFO has special requirements, including an election on Form 970 and a conformity rule for financial statements issued to owners and creditors.

Example

A store buys 100 units at $10, then 100 at $12, and sells 100. Under FIFO, cost of goods sold is $1,000; under LIFO, $1,200.

Other methods

• Average cost: each unit carries the weighted average cost
• Specific identification: used for unique, high-value items such as vehicles or jewelry

Consistency

Whichever method you use must be applied consistently, and changing generally requires IRS consent. Many small businesses use FIFO or average cost, which most inventory and point-of-sale systems support.

See inventory accounting basics and landed cost.

Related terms

• Cost of Goods Sold: Cost of goods sold is the direct cost of the products a business sold during a period.
• Landed Cost: Landed cost is the total cost of getting a product to your location ready for sale, including purchase price, freight, duties and fees.

Browse more definitions in the small business glossary.