FIFO vs LIFO Inventory Costing
Calculate cost of goods sold and ending inventory using both FIFO and LIFO methods. Analyze the impact on financial statements during rising prices.
Calculate cost of goods sold and ending inventory using both FIFO and LIFO methods. Analyze the impact on financial statements during rising prices.
Problem Scenario
Taylor Company uses a periodic inventory system. Beginning inventory and purchases for the month are: Beginning inventory: 100 units @ $10 each. Purchase 1 (Mar 5): 150 units @ $12 each. Purchase 2 (Mar 15): 200 units @ $14 each. Purchase 3 (Mar 25): 50 units @ $15 each. Units sold during March: 350 units at $25 each.
Given Data
Requirements
- Calculate ending inventory and COGS using FIFO
- Calculate ending inventory and COGS using LIFO
- Calculate gross profit under each method
- Explain which method results in lower taxes
Solution
Step 1:
Calculate total goods available and units remaining: Total units = 100 + 150 + 200 + 50 = 500 units. Ending inventory = 500 - 350 = 150 units.
Step 2:
FIFO Method (First In, First Out): Oldest costs go to COGS. COGS = 100 @ $10 + 150 @ $12 + 100 @ $14 = $1,000 + $1,800 + $1,400 = $4,200. Ending Inventory = 100 @ $14 + 50 @ $15 = $1,400 + $750 = $2,150.
Step 3:
LIFO Method (Last In, First Out): Newest costs go to COGS. COGS = 50 @ $15 + 200 @ $14 + 100 @ $12 = $750 + $2,800 + $1,200 = $4,750. Ending Inventory = 100 @ $10 + 50 @ $12 = $1,000 + $600 = $1,600.
Step 4:
Gross Profit Calculation: Revenue = 350 × $25 = $8,750. FIFO Gross Profit = $8,750 - $4,200 = $4,550. LIFO Gross Profit = $8,750 - $4,750 = $4,000.
Final Answer
FIFO: COGS = $4,200, Ending Inventory = $2,150, Gross Profit = $4,550. LIFO: COGS = $4,750, Ending Inventory = $1,600, Gross Profit = $4,000. LIFO results in $550 lower gross profit and thus lower taxes during rising prices.
Key Takeaways
- ✓In rising prices: FIFO = higher income, higher taxes; LIFO = lower income, lower taxes
- ✓FIFO ending inventory is closer to current costs
- ✓LIFO COGS is closer to current costs (better matching)
- ✓LIFO is not allowed under IFRS, only US GAAP
Common Errors to Avoid
- ✗Mixing up which costs go to COGS vs ending inventory
- ✗Calculating the wrong number of units in ending inventory
- ✗Forgetting to verify: COGS + Ending Inventory = Goods Available
FAQs
Common questions about this problem type
During periods of rising prices, LIFO produces lower taxable income and thus lower tax payments. This cash flow benefit can be significant. However, LIFO also results in older, lower costs on the balance sheet.
COGS + Ending Inventory should always equal Cost of Goods Available for Sale. Check: FIFO: $4,200 + $2,150 = $6,350. LIFO: $4,750 + $1,600 = $6,350. Both equal the total goods available.
FIFO and LIFO are cost flow assumptions, not physical flow assumptions. The same units ship regardless of method — what changes is which cost gets assigned to COGS and which stays in ending inventory. In rising prices, this choice significantly impacts reported profit, taxes, and balance sheet values.
Weighted average calculates a single average cost per unit: Total Cost of Goods Available / Total Units Available. All units sold and on hand are valued at this average cost. It produces COGS and ending inventory values between FIFO and LIFO. Under a perpetual system, the average is recalculated after each purchase (moving average).