BIWS Inventory Costs: LIFO vs.

FIFO
($ in Millions Except Per Share Amounts in $ as Stated)

IMPORTANT NOTE: This lesson is only relevant if you're in the US. Under IFRS, LIFO is not allowed
and so you must use FIFO for Inventory and COGS. Skip this if you're not in the US!

Assumptions & Model Output Who Cares About LIFO vs. FIFO?

Assumptions: Earlier, we made a very simple assumption for Inventory and COGS on the statements…
Tax Rate: 40%
Product Units Sold During the Year: 40 COGS = Decrease in Inventory over a specific period.
Per-Unit Product Selling Price: $ 30
Change in Inventory = Beginning Inventory + Purchases - COGS.
Inventory Purchases: Units: Unit Cost: Value:
Beginning Inventory: 10 $ 10 $ 100 Buy some inventory and then turn it into finished products and sell it to customers.
Q1 Units Ordered: 10 12 120
Q2 Units Ordered: 10 15 150 PROBLEM: What do you actually list for COGS? After you buy the Inventory, what should you
Q3 Units Ordered: 10 17 170 record for the cost of Inventory once it's actually sold?
Q4 Units Ordered: 10 20 200
Total: 50 $ 740 Example: Let's say you order 100 units during the course of the year, and initially they cost
you $10 each… but by the end of the year the cost has increased to $20 each.
Income Statement
When you sell 10 units, do you use 10 * $10 for COGS, or 10 * $20?
LIFO: FIFO: Average:
Revenue: $ 1,200 $ 1,200 $ 1,200 That's the core problem you face when recording COGS and Inventory, and there are 2 methods
Cost of Goods Sold (COGS): 640 540 590 for handling it:
Gross Profit: 560 660 610
LIFO (Last In, First Out): You use the cost of the latest items purchased (10 * $20).
Operating Expenses: 460 460 460
FIFO (First In, First Out): You use the cost of the earliest items purchased (10 * $10).
Operating Income: 100 200 150
Net Interest Income: - - - Which one is better? Well, IFRS would have you think that FIFO is better since they don't even
Pre-Tax Income: 100 200 150 allow LIFO… but it's more complicated than that.
Income Tax Provision: 40 80 60
It's less about being "better," and more about the trade-offs between these two methods -
Net Income: $ 60 $ 120 $ 90 how are Net Income, Inventory, and COGS affected?
Balance Sheet - Change in Inventory LIFO vs. FIFO - Recap and Summary:

LIFO: FIFO: Average: Neither one is necessarily "better," but there are trade-offs to both methods.
Beginning Inventory: $ 100 $ 100 $ 100
Purchases: 640 640 640 LIFO: Record cost of latest items purchased for COGS.
Cost of Goods Sold (COGS): (640) (540) (590)
Ending Inventory: $ 100 $ 200 $ 150 FIFO: Record cost of earliest items purchased for COGS.

If inventory costs have been increasing…

LIFO: Higher COGS, lower Net Income, lower ending Inventory balance.

FIFO: Lower COGS, higher Net Income, higher ending Inventory balance.

If inventory costs have been decreasing…

LIFO: Lower COGS, higher Net Income, higher ending Inventory balance.

FIFO: Higher COGS, lower Net Income, lower ending Inventory balance.

Compromise: Take the average (many US-based companies do this in real life).

This comes up in real life all the time, so you need to be aware of it - and possibly be ready to
make adjustments on the financial statements if companies are using different standards for
inventory and COGS.