What Is LIFO (Last In, First Out)?

LIFO (last in, first out) is an inventory costing method that treats the most recently purchased stock as the first to be sold or used. When prices are rising, that means the newest, most expensive costs are matched against sales first - lowering reported profit and, in the United States, lowering current tax. LIFO is permitted under US GAAP but prohibited under IFRS, so it is in practice an American method.

How LIFO works

Like FIFO, LIFO thinks of stock in “layers” - each purchase creates a layer of units at that price. The difference is the direction of consumption: under LIFO, sales draw from the newest layer first. Older layers can sit untouched on the books for years, frozen at their original purchase prices.

Crucially, LIFO is a cost-flow assumption, not a handling rule. A wholesaler can rotate physical stock oldest-first - and verify it with regular cycle counts - while still applying LIFO costing on paper. The books and the shelf are allowed to disagree about which unit “left”.

A worked example

A distributor buys the same item twice:

• 1st of the month: 100 units at €2.00 each
• 15th of the month: 100 units at €2.50 each

It sells 150 units. Under LIFO:

• The first 100 sold are costed from the newest layer: 100 × €2.50 = €250
• The next 50 come from the older layer: 50 × €2.00 = €100
• Cost of goods sold: €350
• Closing stock: 50 units × €2.00 = €100

Compare FIFO on identical facts: cost of goods sold €325 and closing stock €125. Same units, same sales - LIFO simply reports €25 less profit and a lower stock value because prices rose between the two purchases.

Where LIFO is allowed

LIFO is permitted under US GAAP and under US tax law, with a string attached known as the conformity rule: a company that uses LIFO for tax must also use it in its financial statements. IFRS prohibits LIFO outright, so businesses reporting under IFRS - including essentially all listed companies in the EU and UK - use FIFO or weighted average cost. For anyone outside the US, LIFO is mainly a term to recognise rather than a method to adopt.

LIFO vs FIFO in practice

The practical differences when prices are rising:

• Profit and tax - LIFO reports lower profit now (newer, dearer costs hit the P&L first); FIFO reports higher profit.
• Balance sheet - LIFO carries stock at old prices that drift further from reality each year; FIFO values stock near current replacement cost.
• Complexity - LIFO layers demand careful record-keeping, and the gap between book value and market value (the “LIFO reserve”) has to be tracked and disclosed.

One trap is LIFO liquidation: if stock levels fall - after deliberate destocking, or a stockout that was never fully replenished - sales start consuming old, cheap layers, and years of deferred profit land in a single period. Businesses that keep quantities steady around a sensible par level avoid digging into those layers unintentionally.

Common misreadings

Two mistakes come up constantly. First, assuming LIFO describes physical rotation - selling the newest stock first is usually bad practice (old stock expires or goes stale and becomes inventory shrinkage), and LIFO does not require it. Second, assuming the choice is free: where you report determines what is allowed, and under IFRS the answer is simply no.

Related terms

• Par Level - the minimum quantity kept on hand; steady levels prevent accidental LIFO liquidation
• Inventory Shrinkage - stock lost to expiry, damage, theft, or error
• Backorder - an order accepted while an item is temporarily out of stock
• Stockout - running out of an item entirely
• Cycle Count - rolling partial counts that keep stock records honest regardless of costing method