How to Calculate LIFO & FIFO

There are a number of ways to calculate inventory.

Corporate managers and investors closely monitor the value of a company's inventory to determine how quickly the company sells the goods it produces. A growing inventory balance suggests that the company is not producing goods people want; additionally, carrying a large inventory balance reduces the company's cash flow because producing the inventory costs money. There are a number of ways to calculate inventory, but the two most popular are the last-in-first-out (LIFO) method and the first-in-first-out (FIFO) method. Under LIFO, the newest units in inventory are assumed to be sold first, so the cost of goods sold is based on the most recent inventory costs. Under FIFO, the oldest units are assumed to be sold first, so the cost of goods sold is based on historical inventory costs.

Calculating LIFO

Step 1

Download the price and unit list of the products currently in the company's inventory. The price list will include the number of units purchased and the prices at which the units were purchased. The information will be ranked according to date of purchase; the units purchased most recently will be at the top of the list.

Step 2

Determine the number of units sold from inventory. Suppose the company sold 350 units of inventory on August 1.

Step 3

Multiply the prices the company paid for the most recent units by the number of units sold to determine LIFO cost of goods sold. Suppose the company purchased 100 units of inventory for $5 on January 1, 200 units for $8 on March 1, and 100 units for $10 on June 1. The LIFO cost of goods sold for these units would equal (100 x $10) + (200 x $8) + (50 x $5) = $2,850. The value of units remaining in inventory according to LIFO equals (50 x $5), or $250.

Calculating FIFO

Step 1

Download the same price and unit list of the products currently in the company's inventory, and rank the information according to date so that the most recent inventory purchases are at the top of the list.

Step 2

Determine the number of units sold from inventory. Using the same example, suppose the the company sold 350 units on August 1.

Step 3

Multiply the prices the company paid for the oldest units by the number of units sold to determine the FIFO cost of goods sold. Again, suppose the company purchased 100 units of inventory for $5 on January 1, 200 units for $8 on March 1 and 100 units for $10 on June 1. The FIFO cost of goods sold for these units will equal (100 x $5) + (200 x $8) + (50 x $10) = $2,600. The value of units remaining in inventory according to FIFO equals (50 x $10), or $500.

Tip

LIFO and FIFO are cost-flow assumption methodologies that have nothing to do with the physical flow of a company’s inventory. Most companies sell the oldest units in inventory first to avoid spoilage or product obsolescence. However, these companies can account for their inventory using the LIFO method, even though the oldest units in inventory are physically being sold first.

Warning

LIFO and FIFO have different implications for a company’s income and cash-flow statements. In an inflationary environment, when prices are rising, LIFO will result in higher cost of goods sold, lower gross margins and lower profitability, but also lower taxes, because the sold units will be accounted for using the most recent, higher costs. Conversely, FIFO will result in lower cost of goods sold, higher gross margins and higher profitability, but also higher taxes, because the sold units are accounted for using the older, lower costs.

Things You'll Need

  • Inventory tracking software

  • Calculator or spreadsheet program

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