FIFO vs LIFO when prices rise: 2,600 COGS, 1,000 inventory
A company buys 300 units at rising prices and sells 200 of them. Under LIFO, cost of goods sold is 2,600 and ending inventory is 1,000. A candidate who carries the phrase “LIFO costs more” onto the balance sheet reports inventory of 1,400, which is the FIFO figure. Rising prices push COGS up and inventory down at the same time, and the two directions are opposite by construction.
Three numbers move, and they never move the same way
Cost of goods sold and ending inventory split one fixed pool. Goods available for sale is a single amount, and every costing method just decides which slice of it leaves through the income statement and which slice stays on the balance sheet. Add them and the total is identical under FIFO, LIFO, and weighted average. So a method that raises one has to lower the other. There is no version of the question where both go up.
Goods available for sale = Beginning inventory + Purchases = COGS + Ending inventory
When prices are rising, LIFO charges the newest and most expensive units to COGS and leaves the oldest and cheapest ones in inventory. FIFO does the reverse. That gives LIFO the higher COGS, the lower gross profit, the lower net income, the lower ending inventory, and the lower tax bill. Weighted average lands between the two, always.
Working the 300-unit example
Beginning inventory is 100 units at 10. The company then buys 100 units at 12 and 100 units at 14. It sells 200 units at 20 each, leaving 100 units on hand. Goods available for sale is 300 units costing 3,600.
FIFO COGS = (100 × 10) + (100 × 12) = 2,200, and ending inventory = 100 × 14 = 1,400
LIFO COGS = (100 × 14) + (100 × 12) = 2,600, and ending inventory = 100 × 10 = 1,000
Weighted average cost per unit = 3,600 ÷ 300 = 12, so COGS = 2,400 and ending inventory = 1,200
Each pair sums to 3,600. That is the fastest check available on this question type, and it costs one addition.
Revenue is 200 × 20 = 4,000. With no other operating costs and a 25 percent tax rate:
FIFO pre-tax income = 4,000 − 2,200 = 1,800, tax = 450, net income = 1,350
LIFO pre-tax income = 4,000 − 2,600 = 1,400, tax = 350, net income = 1,050
LIFO reports 300 less profit and pays 100 less tax. The 100 is real cash that stays in the business, which is the whole reason a US filer elects LIFO in the first place. The 300 is an accounting outcome. Questions that ask which method produces the better cash position and which produces the better reported earnings are asking about two different lines, and the answers point in opposite directions.
What the LIFO reserve lets an analyst undo
A LIFO filer discloses the LIFO reserve, the gap between the inventory it reports and the inventory FIFO would have shown. In the example above that gap is 1,400 − 1,000 = 400, and it equals the COGS difference of 2,600 − 2,200 exactly, because both come from the same split of the same pool.
LIFO reserve = FIFO inventory − LIFO inventory
FIFO COGS = LIFO COGS − Change in LIFO reserve
Note the second formula uses the change in the reserve over the period, not its level. The level converts a balance sheet; the change converts an income statement. Mixing the two is a common way to produce a number that looks plausible and is not on the answer sheet.
The reserve also carries a warning. If it shrinks while gross profit rises, the company may have sold more units than it bought and pulled old cheap layers into COGS. That is a LIFO liquidation, and the margin improvement it creates is a one-off that says nothing about operations.
Quick reference
| Question wording | What it establishes | Risk if missed |
|---|---|---|
| “Prices are rising” | LIFO gives higher COGS and lower ending inventory | Reversing one of the two directions |
| “Prices are falling” | Every direction above flips | Applying the memorized rising-price answer |
| “Reports under IFRS” | LIFO is not available, so the choice is FIFO or weighted average | Selecting a LIFO answer that cannot exist |
| “LIFO reserve of X” | Level adjusts inventory, change adjusts COGS | Using the level where the change belongs |
| “Inventory quantities declined” | Possible LIFO liquidation inflating gross profit | Reading the margin gain as sustainable |
One structural fact settles a whole class of these questions: IFRS does not permit LIFO. IAS 2 allows FIFO, weighted average cost, and specific identification for interchangeable goods, and nothing else. US GAAP does permit LIFO, with a catch in the tax code rather than the accounting standard. A US company that uses LIFO on its tax return must also use it in the financial statements it gives shareholders and creditors. So “which method reports the higher net income” and “which method the company would prefer for tax” cannot be answered independently by a US filer. It picks once.
The direction problem here is the same one in the cash conversion cycle, where days payable is subtracted while the other two terms are added. In both cases the arithmetic is trivial and the sign is the entire question.
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