First in, first out; last in, first out
First in, first out (FIFO) and last in, first out (LIFO) are inventory-costing methods. Inventory costing methods are used to assign values to a firm’s ending inventory and to COST OF GOODS SOLD
. For tax purposes, a firm will use the inventory-costing method that maximizes its cost of goods sold and minimizes the value of its ending inventory. When unit costs are rising, as is normally experienced with INFLATION
, LIFO is the inventory costing method of choice. To illustrate the effects of FIFO and LIFO, assume the following inventory data where unit costs are rising:
For the month of January, what is the firm’s cost of goods sold? What is the value of the ending inventory at the end of the month? To answer these questions, the firm must first select an inventory-costing method. Using FIFO, cost of goods sold and the value of ending inventory are determined as follows:
Using FIFO, cost of goods sold is $1,600; using LIFO, $1,700. In order to maximize cost of goods sold and, in turn, reduce gross margin and taxable INCOME
, a PROFIT
maximizing firm uses LIFO when unit costs are rising. When unit costs are falling over time, FIFO is the inventory-costing method that maximizes the cost of goods sold.