1. Short Answer: What Is the Difference?

FIFO (first-in, first-out) assigns the oldest purchase costs to COGS; LIFO (last-in, first-out) assigns the newest costs to COGS; and weighted average assigns a blended unit cost. These are cost-flow assumptions, not necessarily descriptions of the physical movement of goods. The selection affects reported earnings and inventory carrying values when acquisition costs change.

2. Define Each Inventory Method

• FIFO: Earlier inventory costs are expensed first. Ending inventory generally reflects more recent purchases, which can be useful when costs are rising.
• LIFO: Recent inventory costs are expensed first. In inflationary periods, it typically increases COGS and reduces reported profit. LIFO is allowed under U.S. GAAP, but not IFRS.
• Weighted average: Total cost of goods available is divided by total units available to determine one average unit cost. Under a periodic approach, the average is calculated for the period; under a perpetual system, moving averages may be recalculated after purchases.

3. Side-by-Side Comparison

4. Practical Example: Identical Transactions, Different Results

A retailer purchases 100 units at $10, another 100 at $12, and another 100 at $14. It sells 180 units at $20 each. Total goods available: 300 units costing $3,600. Sales revenue: $3,600. Assume a periodic inventory system, no opening inventory, and no write-downs.

5. When Each Method Applies: Key Trade-Offs

• FIFO is often practical when goods physically move in approximate purchase order or when management wants ending inventory costs to reflect newer purchases. During inflation, the higher reported profits may also produce higher taxable income, all else equal.
• LIFO can match more recent costs with current revenues during inflation. However, it creates LIFO layers, may lead to LIFO liquidation effects, and requires careful U.S. tax and reporting analysis.

• Weighted average is often useful for large volumes of interchangeable products where individual cost layers are less informative. It smooths unit-cost fluctuations but may mask sharp changes in replacement costs.

6. Decision Guidance, Exceptions, and Summary

• Consider the reporting framework: Under ASC 330, FIFO, LIFO, and weighted average are acceptable cost-flow assumptions. IAS 2 permits FIFO and weighted average, but not LIFO.
• Separate cost assignment from subsequent measurement: Under U.S. GAAP, FIFO and average-cost inventory generally use the lower of cost and net realizable value; LIFO inventory generally uses the lower of cost or market rules.
• Evaluate tax consequences: U.S. tax LIFO elections generally require IRS Form 970 and compliance with applicable LIFO conformity requirements. A switch in inventory accounting methods may require additional accounting and tax analysis or approvals.
• Account for other methods: Specific identification may be appropriate for unique, individually traceable items; standard cost or retail inventory methods may also be used where permitted and appropriate.
• Include the full inventory cost: Depending on the inventory and production activity, costs may include purchase prices, freight-in, import duties, direct labor, and allocable manufacturing overhead—not just supplier invoice prices.
• Document method changes: Changing a financial-reporting cost-flow assumption may require U.S. GAAP accounting-change analysis and disclosures. A federal tax inventory-method change may require IRS Form 3115, consent, and a Section 481(a) adjustment; LIFO adoption and termination have additional rules.

Technical references

• FASB ASC 330—Inventory
• FASB ASC 250—Accounting Changes and Error Corrections
• IFRS IAS 2—Inventories
• IRS Publication 538
• IRS Form 970
• IRS Form 3115
• IRC §481(a)

This article is for general educational purposes; specific reporting and tax conclusions depend on the company’s facts and applicable requirements.