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FIFO and LIFO are methods used in the cost of goods sold calculations in financial accounting. FIFO stands for First in First out and it assumes that the oldest products / materials / items in a company’s inventory have been sold first and goes by those production costs. However contrary to it, The LIFO stands for Last In First Out and this method assumes that the most recent products in a company’s inventory have been sold first and uses costs of recent products instead. These methods are used to manage assumptions of costs related to inventory, stock repurchases (if purchased at different prices), and various other accounting purposes. Below diagram clearly explains the difference between the two methods : If we want to understand LIFO and FIFO concept in Day to Day activities, Imagine a Railway Ticket counter for FIFO : (Person who gets in queue 1st is the 1st to get out normally ) However imagine a Ticket Checker following the concept of LIFO i.e. The Person who got into the train last shall be checked for ticket 1st (As probability of not having ticket is high). Lets understand the difference between the two methods and benefits of each one of these with Financial Aspects now ! FIFO (First In First Out) : In FIFO method, oldest inventory items are recorded as sold first (but this does not necessarily mean that the exact oldest physical object was tracked and sold). Here, the cost associated with the inventory that was purchased first is the cost expensed first.A company might use the LIFO method for accounting purposes, even if it uses FIFO (First In First Out) method for inventory management purposes (i.e., for the actual storage, shelving, and sale of its merchandise). E.g. If a company that sells many perishable goods, such as a supermarket chain, is likely to follow the FIFO method when managing inventory so that goods with earlier expiry dates are sold first and goods with later expiry dates thereafter. However, this does not mean that same company can not use LIFO method for accounting for its merchandise management. While using the FIFO method, the cost of inventory reported on the balance sheet represents the cost of the inventory which was purchased most recently. FIFO most closely represents the flow of inventory, as businesses are likely to sell the oldest inventory first. Lets see this with example as below where say company XYZ has following inventory in had of 600 units those were purchased at different point of time with cost as mentioned : Number of Units Cost (INR) 100 units (1st) 100 INR 200 units (2nd) 150 INR 300 units (3rd) 200 INR Now say company sells 550 units and then the company would expense the cost of 1st 100 units at 100 INR (Lot 1) and next 200 units at 150 INR (Lot 2) and remaining 250 units at 200 INR (Lot 3) using the FIFO method. So here the total cost of Sales will be (100*100) + (200*150) + (250*200) = 10000 + 30000 + 50000 = 90000 INR. And cost of remaining inventory i.e. 50 units (600 total – 550 sold) will be calculated as per cost / unit for the latest lot i.e. 50*200 = 10000 INR and hence the balance sheet will show this amount as Inventory Value. As per FIFO method, company will have low cost of goods sold and high inventory value and therefore profits here will be shown as high (Profit = Sales – Cost of Goods Sold) due to lower cost of Goods sold and hence company will be liable to pay higher taxes. LIFO : (Last In First Out) In this method, most recently produced items are recorded as sold first. From 1970s, some U.S. companies shifted towards the use of LIFO, which reduces their income taxes at the times of inflation, but International Financial Reporting Standards (IFRS) banned LIFO method and hence more companies returned to FIFO. LIFO method is used only in United States and it is governed by the Generally Accepted Accounting Principles (GAAP). Section 472 of the Internal Revenue Code throws the light on how to use the LIFO method. In the example above, company XYZ using LIFO would expense the cost associated with the first 300 units at 200 INR, next 200 units at 150 INR, and the remaining 50 units at 100 INR. Under LIFO, the total cost of sales would be = (300*200) + (200*150) + (100*50) = 95000 and the ending inventory would be calculated as follows : Remaining 50 units = 50*100 = 5000 INR, so here the balance sheet will show 5000 INR as Inventory value in contrary to 10000 INR using FIFO and profit here will be shown as low due to higher cost of Goods Sold and hence the company would be paying the less taxes here than using the FIFO method. The difference in value of inventory calculated using the LIFO and FIFO methods is called as LIFO reserve which is 10000 INR – 5000 INR = 5000 INR in this example and This reserve is the amount by which company’s taxable income has been deferred by using the LIFO method.As a rule in the United States, publicly traded entities which use LIFO for taxation purposes must also use LIFO for financial reporting purposes as well and such companies should report LIFO reserve to its shareholders. Examples of the Companies that use LIFO method : (US Only) General Electric, Walmart, DOW, Caterpillar and ExxonMobil etc. Examples of companies that uses FIFO method : Sectors Prefer to use LIFO Methods : Where there is high difference in prices of goods / materials purchased) i.e. Petroleum, Pharmaceuticals , Retail etc. Sectors use FIFO Method : Where the Shelf Life is quite less and not much variation in Prices on daily basis. E.g. Dairy Products, Fruits and Vegetable Vendors, Courier Services etc. So in nutshell, Companies use LIFO to take tax benefits and to trade off the inflation effects on profits in highly price volatile industries. However, this is used in US only as its banned everwhere else. FIFO is worldwide accepted and simple and clear method of accounting and largely companies use this only.