Understanding FIFO vs LIFO vs Weighted Average Costing
The method an enterprise utilizes to value its inventory directly dictates its reported Cost of Goods Sold (COGS), taxable net income, and balance sheet strength under GAAP and IFRS.
Core Differences Between Costing Methods
- FIFO (First In, First Out): Assumes the earliest acquired units are sold first. During inflationary cycles, FIFO assigns older, cheaper purchase costs to COGS, maximizing reported profits and inventory asset value. Allowed globally under both US GAAP and IFRS.
- LIFO (Last In, First Out): Assumes the most recently acquired, expensive units are sold first. LIFO raises COGS and depresses paper profits, shielding businesses from corporate tax under the IRS LIFO conformity rule. Note: LIFO is permitted under US GAAP, but prohibited under international IFRS.
- Weighted Average Cost (WAC): Divides total cost of goods available for sale by total available units, creating a stabilized, non-volatile blended cost per unit.