FIFO vs LIFO — how exactly do they affect COGS, ending inventory, and net income during rising prices?

This is a classic CFA Level I FRA question and it shows up on nearly every exam. The key is understanding how the cost flow assumption determines which costs go to COGS (income statement) versus ending inventory (balance sheet).

The Rule of Thumb (Rising Prices):

Metric	FIFO	LIFO
COGS	Lower (older, cheaper costs)	Higher (newer, expensive costs)
Ending Inventory	Higher (newer, expensive costs remain)	Lower (older, cheaper costs remain)
Gross Profit	Higher	Lower
Net Income	Higher	Lower
Taxes	Higher	Lower

Worked Example:

Hargrove Supply Co. sells industrial fasteners. In Q1, their purchases were:

Date	Units	Unit Cost	Total Cost
Jan 5	200	$10	$2,000
Feb 12	300	$12	$3,600
Mar 20	250	$15	$3,750
Total	750		$9,350

During Q1, Hargrove sold 500 units at $22 each. Revenue =$11,000.

Under FIFO (sell oldest first):

• COGS = (200 x $10) + (300 x$12) = $2,000 +$3,600 = $5,600
• Ending inventory = 250 x $15 = **$3,750**
• Gross profit = $11,000 -$5,600 = $5,400

Under LIFO (sell newest first):

• COGS = (250 x $15) + (250 x$12) = $3,750 +$3,000 = $6,750
• Ending inventory = (200 x $10) + (50 x$12) = $2,000 +$600 = $2,600
• Gross profit = $11,000 -$6,750 = $4,250

The Impact:

• FIFO shows **$1,150 more gross profit** ($5,400 vs $4,250)
• FIFO shows **$1,150 more in ending inventory** ($3,750 vs $2,600)
• At a 25% tax rate, FIFO results in $287.50 more in taxes

Why It Matters for Analysis: When comparing two companies using different methods, you need to adjust. The LIFO reserve (disclosed in footnotes) lets you convert LIFO to FIFO:

• FIFO inventory = LIFO inventory + LIFO reserve
• FIFO COGS = LIFO COGS - Change in LIFO reserve

Important note: IFRS does not allow LIFO. Only US GAAP permits it. The exam loves testing this distinction.

For a deeper dive into inventory methods and their analytical adjustments, check out our CFA Level I Financial Reporting course on AcadiFi.