FIFO, LIFO, or Average: How the Same Inventory Produces Different Profits

The companion calculator computes cost of goods sold from beginning inventory, purchases, and ending inventory. That formula is only complete once you answer a hidden question: when units cost different amounts at different times, which units do you count as sold? The choice of inventory costing method can change reported profit and tax bills substantially, using the exact same physical inventory.

The Problem: Prices Change

If every unit always cost the same, cost of goods sold would be unambiguous. But prices drift, so a warehouse holds identical products bought at different costs. When you sell one, which cost do you assign to it, the old cheap one or the new expensive one? Your answer determines both the cost of goods sold (which hits profit) and the value of the ending inventory left on the balance sheet. Three main conventions exist to answer it.

Crucially, these are cost-flow assumptions, not necessarily how the physical goods actually move. A grocery may physically sell oldest stock first but still choose a different costing method for its books.

Why It Matters Most During Inflation

When prices are rising, the methods diverge sharply, and the effect on profit and tax is the whole point.

So in inflationary times LIFO shows lower profits and, importantly, a lower tax bill, because it charges the newest, highest costs against revenue. FIFO shows healthier profits but a bigger tax bill. The same sales, the same goods, a different bottom line, purely from the costing choice.

Why LIFO Is a US-Only Curiosity

Here is a genuine oddity: LIFO is permitted under US accounting rules but banned under the international standards most of the world uses. Critics argue LIFO can distort the balance sheet, leaving ending inventory valued at very old, unrealistic costs, and that it exists largely as a tax-reduction device. US companies that use LIFO often disclose a LIFO reserve, the difference between their LIFO inventory value and what it would be under FIFO, so readers can compare. Outside the US, the choice is essentially FIFO versus weighted average.

Consistency Is the Rule

Whichever method a business picks, it must apply it consistently period to period, because switching methods would make results incomparable and could be used to manipulate profit. This is exactly why the calculator's note stresses keeping the same valuation method across periods, the beginning and ending inventory figures only reconcile if they are measured the same way.

Using the COGS Figure Well

Take the calculator's cost of goods sold as accurate for the inventory figures you enter, and recognize that those figures depend on your costing method. Understand that FIFO, LIFO, and weighted average can produce meaningfully different profit and tax outcomes on identical inventory, especially when prices are moving, that LIFO is a US-only option often chosen for its tax effect, and that consistency across periods is essential. The specific method choice and its tax implications are worth discussing with an accountant.