The Last-In, First-Out (LIFO) inventory method results in lower taxable income during inflation but is not permitted under International Financial Reporting Standards (IFRS). By assuming the most recent, higher-cost inventory is sold first, LIFO increases the Cost of Goods Sold (COGS), reducing net income and tax liabilities, but it is restricted to U.S. GAAP.
FIFO is compliant with both GAAP and IFRS, making it widely accepted internationally. LIFO, however, is only allowed under GAAP and is prohibited by IFRS, meaning businesses using LIFO cannot comply with international financial reporting standards.
In some cases — particularly during periods of high inflation and stable inventory levels — adopting the last-in, first-out (LIFO) method could significantly reduce your taxable income and boost your cash flow.
The recent surge in inflation has led managers to reassess the best inventory valuation methods—first-in-first-out (FIFO) or last-in-first-out (LIFO). In times of rising prices, FIFO typically results in higher earnings, while LIFO can reduce tax liabilities.
The LIFO method is available only under U.S. Generally Accepted Accounting Principles (GAAP) — it's not permitted under International Financial Reporting Standards (IFRS).
Both GAAP and IFRS allow First In, First Out (FIFO), weighted-average cost, and specific identification methods for valuing inventories. However, GAAP also allows the Last In, First Out (LIFO) method, which is not allowed under IFRS.
Investors understand that older costs leave first, making the income statement easier to read. If you sell across borders, IFRS requires FIFO or weighted average—never LIFO.
However, LIFO is a strategically valuable accounting method that is most useful during inflation. In other words, FIFO is an ideal method for rising prices, while LIFO should be used when prices fall as expensive products get sold first.
Generally, LIFO lowers both taxable income and financial income, while FIFO raises both taxable income and financial income. Choosing LIFO inventory accounting might be more economically sound, but it can lead to lower reported income to shareholders, which can push managers to adopt FIFO inventory accounting.
LIFO works best when inflation drives up costs. By using the most recent, higher-cost inventory to calculate the cost of goods sold, businesses can reduce taxable income—which frees up cash for reinvestment or daily operations.
In inflationary times, LIFO results in higher reported costs of goods sold and lower net income, which can benefit tax outcomes. FIFO and LIFO provide different valuation results; FIFO shows older costs and possibly higher taxes, while LIFO reflects current costs for reduced tax liabilities.
The IRS requires LIFO to be used for both tax and financial statement purposes in the primary income statement.
In terms of investing in accounting inventory, FIFO is usually a better method for inventory when prices are rising, and LIFO accounting is better when prices fall because more expensive products are sold first.
LIFO is banned under IFRS due to potential financial distortions. LIFO can understate company earnings and lead to outdated inventory values. Under LIFO, tax liabilities are reduced but at the cost of outdated inventory values.
Choosing the Right Inventory Valuation Method
The main difference between International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP) is that IFRS does not allow the LIFO method.
Explanation of Correct Answer:
LIFO (Last In, First Out) is prohibited under International Financial Reporting Standards (IFRS) because it does not accurately reflect the physical flow of inventory in most businesses.
Key Differences in Calculation. FIFO results in lower COGS and higher ending inventory value during inflation. LIFO results in higher COGS and lower ending inventory value, reducing taxable income.
The International Accounting Standards Board (IASB® Board) eliminated the use of LIFO because of its lack of representational faithfulness of inventory flows.
When prices are on the rise, your inventory under LIFO will comprise older and cheaper products, and the newer and more costly items will be charged to COGS first. With a higher COGS, profits and income taxes are generally lower under LIFO.
During periods of inflation, the use of LIFO will result in the highest estimate of cost of goods sold among the three approaches, and the lowest net income.
While LIFO produces a lower tax liability, the FIFO method tends to report a higher net income, which can make the company more attractive to shareholders. It also reports a higher value for current inventory, which can strengthen the company's balance sheet.
One of the primary benefits of using LIFO during an inflationary period is the associated income tax benefit. Matching current rising higher prices against revenues alleviates “inventory profit,” lowers taxable income, and reduces income tax expense.
As LIFO inventory costing is not permitted under IFRS, companies that utilize the LIFO costing methodology under US GAAP might experience significantly different operating results as well as cash flows.
LIFO in Accounting Standards
Under IFRS and ASPE, the use of the last-in, first-out method is prohibited. However, under GAAP, the use of Last-In First-Out is permitted. The inventory valuation method is prohibited under IFRS and ASPE due to potential distortions on a company's profitability and financial statements.
The FIFO inventory method satisfies International Financial Reporting Standards requirements, making it the only acceptable inventory valuation method under IFRS. This global standardization simplifies accounting for multinational companies and ensures consistent financial reporting across different jurisdictions.