Inventory Accounting
Which costs are assigned to goods sold is a policy choice. In a period of changing prices it changes reported profit, taxes and the balance sheet.
MadStockAlerts Research · Updated August 28, 2026
What to take away
- FIFO assigns the oldest costs to goods sold; LIFO assigns the newest.
- In rising prices, LIFO reports lower profit and lower inventory.
- LIFO is permitted under US GAAP and prohibited under IFRS.
- The LIFO reserve discloses the difference and allows a conversion.
- Inventory rising faster than sales is a recurring warning sign.
MAD Academy Training Video · 0:45
Same Warehouse, Different Profit
FIFO and LIFO describe an accounting assumption, not a physical order, and in an inflationary period they report different profits.
This lesson is part of a Stock Alerts + Tools plan.
The methods
| Method | Cost of goods sold uses | In rising prices |
|---|---|---|
| FIFO | The oldest costs | Lower cost of sales, higher profit, higher inventory value |
| LIFO | The most recent costs | Higher cost of sales, lower profit, older inventory values |
| Weighted average | A blended cost | Between the two |
The choice has no effect on the physical flow of goods. A company using LIFO is not selling its newest stock first; it is assigning the newest costs to whatever it sold.
Why it matters for comparison
Two identical companies using different methods report different profit, different inventory and different tax. Comparing their margins directly compares two accounting policies as much as two businesses.
Scroll the chart sideways to see all of it.
- FIFO
- LIFO
The LIFO reserve, disclosed in the notes, is the difference between the two valuations. It is what makes a conversion possible, and it is the standard adjustment for comparing a LIFO filer against a FIFO one.
The IFRS difference
LIFO is not permitted under IFRS. A US company using it therefore cannot be compared directly to an international peer without converting, which is one of the specific differences the foreign issuer article refers to.
In the United States, a company using LIFO for tax purposes must also use it for financial reporting. That linkage is why the method persists despite reporting lower profit: it reduces taxable income in a period of rising prices.
What the balance is telling you
- Inventory rising faster than sales over several periods suggests goods are moving slower than they were.
- Days inventory outstanding expresses the same thing in a comparable unit.
- Write-downs are disclosed and are an admission that the carrying value exceeded what could be realised.
- The composition, between raw materials, work in progress and finished goods, is disclosed and is informative about where a build is occurring.
The last item distinguishes two very different situations. A build in raw materials can be a supply decision; a build in finished goods is products that were made and not sold.
Write-downs and the lower of cost or market
Inventory is carried at the lower of its cost and its net realisable value, which means a decline in what it can be sold for produces a write-down and a charge against profit.
- The write-down is recognised when the value falls, not when the goods are eventually sold.
- Under US GAAP the write-down generally cannot be reversed if values recover.
- Under IFRS a reversal is permitted, up to the original cost.
- A large write-down is disclosed and is an admission that goods were made or bought that cannot be sold at cost.
The fourth item is why write-downs are watched. They quantify a demand misjudgement, and because the charge lands in cost of sales they depress the gross margin in the period taken and flatter it afterwards, since the written-down goods carry a lower cost.
That second-order effect is worth knowing about. A gross margin that improves sharply in the period after a large write-down is improving partly because the inventory being sold was written down, which is not the same as an operational improvement.