Inventory and COGS: LIFO vs FIFO (13:39)
In this lesson, you’ll learn how Inventory and Cost of Goods Sold (COGS) differ under the LIFO (Last-In, First-Out) and FIFO (First-In, First-Out) methods.
Why LIFO vs. FIFO Matters
In our 3-statement “interview question” model, we assumed that COGS = Decrease in Inventory over a specific period.
So the implicit assumption is:
Change in Inventory = Beginning Inventory + Purchases – COGS.
PROBLEM: What do you actually list for COGS? After you buy the Inventory, what should you record for the cost of Inventory once it’s actually sold?
Example: Let’s say you order 100 units during the course of the year, and initially they cost you $10 each… but by the end of the year the cost has increased to $20 each.
When you sell 10 units, do you use 10 * $10 for COGS, or 10 * $20?
That’s the core problem you face when recording COGS and Inventory, and there are 2 methods for handling it:
LIFO (Last In, First Out): You use the cost of the latest items purchased (10 * $20).
FIFO (First In, First Out): You use the cost of the earliest items purchased (10 * $10).
It’s not about which one is “better,” but more about the trade-offs between these two methods — how are Net Income, Inventory, and COGS affected?
Impact on Net Income, Inventory, and COGS
If inventory costs have been INCREASING:
LIFO: Higher COGS, lower Net Income, and a lower ending Inventory balance.
FIFO: Lower COGS, higher Net Income, and a higher ending Inventory balance.
If inventory costs have been DECREASING:
LIFO: Lower COGS, higher Net Income, and a higher ending Inventory balance.
FIFO: Higher COGS, lower Net Income, and a lower ending Inventory balance.
Compromise: Take the average numbers under both methods (many US-based companies do this in real life).
This comes up in real life all the time, so you need to be aware of it — and possibly be ready to make adjustments on the financial statements if companies you’re comparing are using different standards for inventory and COGS.
