# Understanding LIFO: Last In, First Out Inventory Method

![Last In, First Out](https://www.investopedia.com/thmb/lWvzqjzkk6lm_2R1VvZ8XzYyOEw=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Last-In-First-Out-v1-da47bc6193f44fcda65e4618fb20fb09.png)

*— Investopedia / Lara Antal*

## What Is Last In, First Out (LIFO)?

Last in, first out (LIFO) is a method used to account for business inventory that records the most recently produced items in a series as the ones that are sold first. That is, the cost of the most recent products purchased or produced is the first to be expensed as [cost of goods sold (COGS)](https://www.investopedia.com/terms/c/cogs.asp), while the cost of older products, which is often lower, will be reported as inventory.

 Alternatives to LIFO include [first in, first out (FIFO)](https://www.investopedia.com/terms/f/fifo.asp), where older items are sold first, and the [average cost method](https://www.investopedia.com/terms/a/averagecostmethod.asp), which uses a weighted average of all items to determine costs.

### Key Takeaways

*   The Last In, First Out (LIFO) method assumes the most recently produced inventory is sold first, impacting cost calculations during inflation.  
    
*   LIFO can reduce taxable income in periods of rising costs, which is why it is popular with businesses that maintain large inventories.  
    
*   Unlike the International Financial Reporting Standards (IFRS), U.S. GAAP allows LIFO, making it primarily a U.S. method.  
    
*   In inflationary times, LIFO results in higher reported costs of goods sold and lower net income, which can benefit tax outcomes.  
    
*   FIFO and LIFO provide different valuation results; FIFO shows older costs and possibly higher taxes, while LIFO reflects current costs for reduced tax liabilities.

## How LIFO Accounting Functions and Its Implications

Last in, first out (LIFO) is only used in the United States where any of the three inventory-costing methods can be used under [generally accepted accounting principles (GAAP)](https://www.investopedia.com/terms/g/gaap.asp). The [International Financial Reporting Standards (IFRS)](https://www.investopedia.com/terms/i/ifrs.asp), which is used in most countries, forbids the use of the LIFO method.

Companies like retailers and auto dealerships use LIFO to manage large inventories. It helps reduce taxable income and increase cash flow when expenses rise. The method allows them to take advantage of lower taxable income and higher cash flow when their expenses are rising.

Most U.S. [public companies prefer FIFO](https://www.investopedia.com/ask/answers/052915/how-can-firstin-firstout-fifo-method-be-used-minimize-taxes.asp). If a company uses LIFO for taxes, it must also report financial results under LIFO, which lowers [net income](https://www.investopedia.com/terms/n/netincome.asp).

## LIFO's Impact on Inflation and Net Income

Without [inflation](https://www.investopedia.com/terms/i/inflation.asp), all methods give the same result. But with high inflation, the choice affects valuation. FIFO, LIFO, and average cost impact income differently:

*   FIFO shows a more accurate [ending inventory](https://www.investopedia.com/terms/e/endinginventory.asp) value but raises net income due to older inventory costs. This higher income can lead to higher taxes.
*   LIFO is not a good indicator of ending inventory value because it may understate the value of inventory. LIFO results in lower net income (and taxes) because COGS is higher. However, there are fewer inventory [write-downs](https://www.investopedia.com/terms/w/writedown.asp) under LIFO during inflation.
*   Average cost produces results that fall somewhere between FIFO and LIFO.

In times of deflation, the complete opposite of the above is true.

## Real-World Example: Applying LIFO in Inventory Management

Consider a company with 10 widgets. Five cost $100 each, and five cost $200 each, arriving a day later. Under LIFO, the last received, priciest items sell first. If seven are sold, how much can be recorded as cost?

Each widget has the same sales price, so [revenue](https://www.investopedia.com/terms/r/revenue.asp) is the same. But the cost of the widgets is based on the inventory method selected.

Based on the LIFO method, the last inventory in is the [first inventory](https://www.investopedia.com/terms/b/beginninginventory.asp) sold. This means the widgets that cost $200 sold first. The company then sold two more of the $100 widgets. In total, the cost of the widgets under the LIFO method is $1,200, or five at $200 and two at $100.

With FIFO, the $100 items sell first, then the $200 ones. The recorded cost would be $900, with five at $100 and two at $200.

This is why LIFO creates higher costs and lowers net income in times of inflation. It also reduces [taxable income](https://www.investopedia.com/terms/t/taxableincome.asp).

In periods of deflation, LIFO creates lower costs and increases net income, which also increases taxable income.

## Which Is Better, LIFO or FIFO?

That depends on the business you're in, and whether you run a public company. The LIFO method decreases net income on paper. That reduces the taxes you owe assuming that inflation is at work. If you're running a public company, lower earnings may not impress your shareholders.

Most companies that use LIFO are those that are forced to maintain a large amount of inventory at all times. By offsetting sales income with their highest purchase prices, they produce less taxable income on paper.

## Which Is Easier, LIFO or FIFO?

They don't differ in complexity. You can find an online calculator for either or both from sites like the [OMNI Calculator](https://www.omnicalculator.com/finance/lifo-for-inventories).

## Why Is LIFO Accounting Banned in Most of the World?

[LIFO is banned](https://www.investopedia.com/articles/investing/042115/why-last-first-out-banned-under-ifrs.asp) under the International Financial Reporting Standards that are used by most of the world because it minimizes taxable income. That only occurs when inflation is a factor, but governments still don't like it. It also can make a company's inventory valuations inaccurate. In addition, there is the risk that the earnings of a company that is being liquidated can be artificially inflated by the use of LIFO accounting in previous years.

## Summary: When LIFO Is Most Advantageous

Most companies prefer the FIFO method for inventory accounting, as it provides a clearer reflection of ending inventory values and higher net income, which can be beneficial in stable economic conditions. The LIFO method, however, is advantageous for businesses with large inventories during periods of inflation, as it reduces taxable income by reflecting higher costs of goods sold.

While LIFO helps manage tax liabilities when inflation occurs, it may not present the most accurate inventory valuation and is prohibited under IFRS globally. Each method has distinct implications on financial statements, so businesses must consider their specific economic context and objectives when choosing between LIFO and FIFO.  

> **Article Sources**
>
> 1.  The Wall Street Journal. "[Inflation Has More U.S. Companies Ditching ‘Last-In, First-Out’ Accounting](https://www.wsj.com/articles/inflation-has-more-u-s-companies-ditching-last-in-first-out-accounting-27a0935c)."
>     
> 2.  PwC. "[US Inventory Guide: 3.4 Book/Tax LIFO Conformity Requirements](https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/inventory/Inventory-Guide/3_chapter_LIFO_inv/34_Book_tax_confo_req.html)."
>     
> 3.  The Journal of Accountancy. "[The Death of LIFO?](https://www.journalofaccountancy.com/issues/2009/jan/deathoflifo.html)"
>     
> 4.  Tax Foundation. "[Understanding the Tax Treatment of Inventory: The Role of LIFO](https://taxfoundation.org/research/all/federal/lifo-tax-treatment-inventory/)."
>     
> 5.  Carpenter, Brian W. and et al. "[The Impending Demise Of LIFO: History, Threats, Implications, And Potential Remedies](https://www.researchgate.net/publication/268365773_The_Impending_Demise_Of_LIFO_History_Threats_Implications_And_Potential_Remedies)." _Journal of Applied Business Research_, vol. 28, no. 4, July 2012, pp. 645-650.
>     
> 6.  Tinkelman, Daniel. "[The Rise and Decline of LIFO](https://www.researchgate.net/publication/363206217_The_Rise_and_Decline_of_LIFO)." _Accounting Historians Journal_, vol. 49, no. 2, September 2022, pp. 1-44.