FIFO/LIFO Costing

Layer-based costing methods that track inventory in purchase "layers" or batches.

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How Layer Costing Works

Layer Costing Concept
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Each purchase creates a "layer" with its own cost

FIFO (First In, First Out):
  └── Sell from OLDEST layer first

LIFO (Last In, First Out):
  └── Sell from NEWEST layer first

Layers:
  Layer 1: 100 units @ $10 (oldest)
  Layer 2:  50 units @ $12
  Layer 3:  75 units @ $14 (newest)

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FIFO Costing

How FIFO Works

FIFO Cost Flow
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Purchases create layers (oldest at bottom):

Layer 3:  75 @ $14 = $1,050  ← Newest
Layer 2:  50 @ $12 = $600
Layer 1: 100 @ $10 = $1,000  ← Oldest

Sale of 120 units:
  From Layer 1: 100 @ $10 = $1,000 (depleted)
  From Layer 2:  20 @ $12 = $240
  ─────────────────────────────────
  COGS: $1,240

Remaining:
  Layer 3: 75 @ $14 = $1,050
  Layer 2: 30 @ $12 = $360 (30 remaining)

FIFO GL Impact

Sale Example:

Account	Debit	Credit	Why?
COGS	$1,240		Cost from oldest layers
Inventory Asset		$1,240	Remove oldest cost

FIFO Sale GL Explained
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Selling 120 units under FIFO:

COGS calculates from oldest inventory:
  100 units from Layer 1 @ $10 = $1,000
   20 units from Layer 2 @ $12 = $240
  ─────────────────────────────────────
  Total COGS: $1,240

This matches the cost of the OLDEST units
(First ones IN are First ones OUT)

FIFO Advantages

Advantage	Description
Matches physical flow	Most businesses sell oldest first
Current inventory value	Ending inventory at recent costs
Higher income (inflation)	Lower COGS when costs rising
GAAP preferred	Generally accepted method

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LIFO Costing

How LIFO Works

LIFO Cost Flow
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Purchases create layers (newest at top):

Layer 3:  75 @ $14 = $1,050  ← Newest (sell first)
Layer 2:  50 @ $12 = $600
Layer 1: 100 @ $10 = $1,000  ← Oldest (sell last)

Sale of 120 units:
  From Layer 3: 75 @ $14 = $1,050 (depleted)
  From Layer 2: 45 @ $12 = $540
  ─────────────────────────────────
  COGS: $1,590

Remaining:
  Layer 2:  5 @ $12 = $60 (5 remaining)
  Layer 1: 100 @ $10 = $1,000

LIFO GL Impact

Sale Example:

Account	Debit	Credit	Why?
COGS	$1,590		Cost from newest layers
Inventory Asset		$1,590	Remove newest cost

LIFO Sale GL Explained
─────────────────────────────────────────────────────────────────

Selling 120 units under LIFO:

COGS calculates from newest inventory:
  75 units from Layer 3 @ $14 = $1,050
  45 units from Layer 2 @ $12 = $540
  ─────────────────────────────────────
  Total COGS: $1,590

This matches the cost of the NEWEST units
(Last ones IN are First ones OUT)

LIFO Advantages

Advantage	Description
Tax benefit (inflation)	Higher COGS = lower taxes
Current cost matching	COGS reflects current costs
Cash flow	Lower taxes = more cash

LIFO Disadvantages

Disadvantage	Description
Not IFRS compliant	Not allowed internationally
Old inventory value	Balance sheet shows old costs
LIFO reserve	Must track difference from FIFO

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FIFO vs LIFO Comparison

Same Transactions - Different Results
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Purchases:
  Jan 1:  100 @ $10 = $1,000
  Jan 15:  50 @ $12 = $600
  Jan 25:  75 @ $14 = $1,050
  ─────────────────────────────
  Total: 225 units, $2,650

Sale: 120 units

FIFO:
  COGS: (100 × $10) + (20 × $12) = $1,240
  Ending Inventory: 105 units = $1,410
  Gross Profit: Higher

LIFO:
  COGS: (75 × $14) + (45 × $12) = $1,590
  Ending Inventory: 105 units = $1,060
  Gross Profit: Lower

Difference: $350 in COGS

Impact on Financial Statements

Item	FIFO	LIFO
COGS	Lower	Higher
Gross Profit	Higher	Lower
Inventory Value	Higher (current)	Lower (old)
Net Income	Higher	Lower
Taxes	Higher	Lower

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Layer Management

Layer Creation

Layer Creation
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Each purchase creates a new layer:

Purchase #1: 100 @ $10 ──▶ Layer 1: 100 @ $10
Purchase #2:  50 @ $11 ──▶ Layer 2:  50 @ $11
Purchase #3:  75 @ $12 ──▶ Layer 3:  75 @ $12

Total: 3 layers, 225 units

Layer Depletion

FIFO Layer Depletion
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Starting Layers:
  Layer 1: 100 @ $10
  Layer 2:  50 @ $11
  Layer 3:  75 @ $12

Sale: 130 units

After Sale (FIFO):
  Layer 1: DEPLETED (used 100)
  Layer 2: DEPLETED (used 50)
  Layer 3:  55 @ $12 (20 used)
  ─────────────────
  Remaining: 1 layer, 55 units

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Returns Impact

Customer Returns

Customer Return - FIFO
─────────────────────────────────────────────────────────────────

Original Sale: 50 units from Layer 1 @ $10 = $500

Return: 10 units

Option 1: Return to original layer
  Layer 1: Increases by 10 @ $10

Option 2: Create new layer (more common)
  New Layer: 10 @ $10

Result: Inventory increases at original cost

Vendor Returns

Vendor Return - LIFO
─────────────────────────────────────────────────────────────────

Return to vendor typically removes from specific layer
or newest layer (LIFO) / oldest layer (FIFO)

Return removes inventory at that layer's cost

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Quick Reference

Layer Costing Rules

Event	FIFO	LIFO
Sale	Consume oldest	Consume newest
Return (customer)	Add to original or new layer	Add to original or new layer
Return (vendor)	Remove from appropriate layer	Remove from appropriate layer

When to Use

Use FIFO When	Use LIFO When
Physical flow is FIFO	Want tax benefits
Need IFRS compliance	Costs are rising
Products are perishable	Want to match current costs
Want higher net income	US company only

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Next Steps

• Average Costing - Weighted average method
• Standard Costing - Fixed costs with variances
• Lot/Serial Costing - Specific identification