FIFO vs. LIFO: Which Inventory Valuation Method Is Best for Your Business?

How you value your inventory can directly shape your profitability, taxes, and operational efficiency. You’ve probably heard the debate: FIFO vs. LIFO — a classic accounting showdown that’s been around for decades.
Which method is best for your business? Let’s break down both approaches, compare advantages, and highlight key compliance facts every U.S. business should know.

What Are Inventory Valuation Methods—and Why They Matter

Inventory valuation methods determine how you assign costs to the products you sell and the inventory you still hold. The method you choose affects your:

  • Cost of goods sold (COGS)

  • Gross margin and net income

  • Tax liability

  • Financial reporting accuracy

Two of the most common valuation methods are FIFO (First In, First Out) and LIFO (Last In, First Out).

FIFO vs. LIFO

 What Is the FIFO Method?

FIFO (First In, First Out) assumes the first items purchased or produced are the first ones sold.
Example: a grocery store sells older stock first so that perishable items don’t expire.

How FIFO Works

When calculating COGS, FIFO uses the cost of your oldest inventory first. Remaining (ending) inventory is valued at your newest costs — which typically align with current market prices.

Advantages of FIFO

  • Ideal for perishable or time-sensitive goods (food, cosmetics, pharmaceuticals, consumer goods).

  • Provides more accurate inventory valuation on the balance sheet, since ending inventory reflects newer (often higher) costs.

  • Globally accepted: FIFO is approved under both U.S. GAAP and International Financial Reporting Standards (IFRS).

  • Easier bookkeeping and inventory tracking compared to LIFO.

 What Is the LIFO Method?

LIFO (Last In, First Out) assumes the most recently acquired items are sold first, leaving older inventory on hand.

Where LIFO Is Used

  • Common in industries with non-perishable goods — such as machinery, metals, or raw materials.

  • Used primarily in the United States; it’s not permitted under IFRS, making it unsuitable for international financial reporting.

Advantages of LIFO

  • In periods of rising prices, LIFO results in higher COGS and lower taxable income, creating a short-term tax benefit.

  • Better matches current costs with current revenues for businesses heavily affected by inflation.

  • Simplifies cost tracking when product prices fluctuate frequently.

Fact check: LIFO is permitted only under U.S. GAAP and the Internal Revenue Code (see IRS Publication 538 and Form 970 instructions).
It is not allowed under IFRS, which bans LIFO due to comparability concerns.

FIFO vs. LIFO: Bookkeeping, Taxes & Inventory Flow

1. Bookkeeping Complexity

  • FIFO assumes older stock sells first, keeping records simple and inventory turnover visible.

  • LIFO can lead to “layered” inventory that’s harder to track, especially if older stock remains unsold for years.

2. Tax Implications

  • LIFO can reduce taxable income in inflationary times, but:

    • It requires filing IRS Form 970 to adopt.

    • Switching back to FIFO later needs IRS approval via Form 3115.

    • Using LIFO may affect loan covenants or investor comparisons, since financials differ from FIFO-based peers.

  • FIFO, while less tax-advantaged during inflation, typically results in higher reported earnings, beneficial for investors or credit evaluations.

3. Inventory Flow Preferences

  • FIFO: Best when products lose value over time or expire.

  • LIFO: Best when item value remains stable and inflation significantly affects replacement cost (e.g., petroleum, building materials).

FIFO/LIFO Examples

Scenario Recommended Method Why
Grocery, cosmetics, pharmaceuticals FIFO Prevents spoilage, keeps inventory fresh, aligns with natural flow.
Construction materials, hardware, industrial parts LIFO Reflects inflation in cost of goods sold; reduces tax burden in rising-cost environments.
E-commerce or retail apparel FIFO Matches real-world sales order; easier financial reporting.

Other Inventory Valuation Methods to Know

Method Overview Best For
Specific Identification Tracks each unit’s exact cost (via serial numbers or barcodes). High-value or unique items (vehicles, jewelry).
Weighted Average (Average Cost) Averages the cost of all units available for sale. Interchangeable, non-perishable items (hardware, apparel).
Retail Method Values inventory based on retail price minus markup. Large retail chains needing quick estimates.
Gross Profit Method Estimates ending inventory using historical gross margins. Interim financial statements or loss claims.

 So, Which Is Best?

There’s no one-size-fits-all answer.

  • FIFO is the most widely used and globally accepted method. It provides transparent reporting and simpler recordkeeping.

  • LIFO can be strategically useful in inflationary periods—but only for U.S. businesses willing to handle added complexity.

If your inventory loses value over time, FIFO is the clear choice.
If your materials rise sharply in cost, LIFO might save you on taxes.
The best method depends on your industry, product type, and tax strategy.

Jay Group Insight

At Jay Group, we see firsthand how accurate inventory valuation strengthens fulfillment operations and client trust. Whether you’re managing perishable goods or durable products, data-driven inventory visibility supports better forecasting, smoother logistics, and healthier margins.