Whether you’re a gigantic warehouse store or a small grocery store, the costs of the goods you sell vary from time to time. When you sell many of the same items, it’s almost impossible to track exactly which items were sold so that you can accurately track the costs of the goods you sell. For example, when a customer picks up a bunch of bananas, how can you determine if those were from the shipment yesterday that you paid 10-cents-per-pound for or from the shipment three days ago that you paid 12-cents-per-pound for? To make recordkeeping easier, many companies use either LIFO or FIFO accounting methods to track the costs of goods sold.
Calculating LIFO for Inventory
“LIFO” stands for last in, first out, and it means that when customers purchase goods, they are treated as buying the most recently purchased inventory for accounting purposes. To calculate the costs of goods sold using the LIFO method, treat the most recently purchased inventory as being sold first.
For example, say you have 190 T-shirts in your inventory. The first batch of 50 tees was purchased for $3 each. The second batch of 75 tees you ordered was purchased for $4 each. The 65 tees in the third batch were purchased for $5 each. Today, you sold 100 T-shirts.
Under the LIFO method, the most recent purchase of 65 tees at $5 each is treated as being sold first, so you multiply 65 by $5 to find your cost of goods sold for that portion is $325. The remaining 45 tees are treated as coming from the second-most recent order that cost $4 per tee, or $180. So, your total cost of goods sold under the LIFO method is $505.
Calculating FIFO for Inventory
“FIFO” stands for first in, first out, and it means that when customers purchase goods, they are treated as buying the oldest items in your inventory first. To calculate the cost of goods sold using the FIFO method, treat the oldest items in your inventory as being sold first.
Using the same example of 190 T-shirts in your inventory, you get a different answer using FIFO than LIFO. When you sell the same 100 tees, the first 50 are treated as being sold from the first batch you received that you only paid $3 each for. So, your cost of goods sold on those items is only $150. The next 50 tees sold are treated as being sold from the middle batch you purchased for $4 each, so your cost of goods sold is $200. That makes the total cost of goods sold $350 – much lower than the $505 calculated under the LIFO method.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."