Think of your inventory as a stack of pancakes: the last one you put on the plate is the first one you eat. That’s the idea behind the last-in, first-out (LIFO) method. It assumes the most recently purchased items are the first ones sold.

LIFO is an accounting assumption, not a rule about how you physically move stock. You can ship your oldest items first and still account for them using LIFO. What changes is the cost you record against each sale, and that affects your profit, your taxes, and the value of your inventory on the balance sheet.

This guide explains how LIFO works, with worked examples, how it compares with FIFO, what it does to your financial statements, and when it’s allowed. For a comparison of all the costing methods, see our guide to inventory costing methods.

What is the LIFO method?

LIFO stands for last-in, first-out. It’s an inventory costing method that assigns the cost of your most recent purchases to the goods you sell first. The cost of your older purchases stays in inventory until later.

It’s one of the main inventory cost flow assumptions, alongside FIFO (first-in, first-out), weighted average cost, and specific identification. Each one is a different rule for deciding which costs become cost of goods sold (COGS) and which remain in ending inventory.

LIFO is permitted under US Generally Accepted Accounting Principles (GAAP), and US tax rules allow it. International Financial Reporting Standards (IFRS) don’t permit it, and many countries’ tax authorities don’t accept it either.

How does the LIFO method work?

Every time you buy stock at a different price, you create a cost “layer.” When you sell, LIFO takes the cost from the newest layer first, then the next newest, and so on. Whatever remains in the older layers is your ending inventory.

When prices are rising, your newest layers cost more than your oldest. LIFO charges those higher costs to COGS, which lowers your reported profit and your taxable income for the period. That’s the main reason businesses choose it.

A step-by-step LIFO example

Suppose you buy 100 units in each of three months, and the price rises each time. You then sell 150 units.

Purchase	Units	Cost per unit	Total cost
January	100	$10	$1,000
March	100	$12	$1,200
June	100	$14	$1,400
Total available	300		$3,600

1. Find the cost of goods available for sale: $1,000 + $1,200 + $1,400 = $3,600 for 300 units.
2. Count the units sold: 150.
3. Take costs from the newest layer first. All 100 June units come first (100 × $14 = $1,400), then 50 of the March units (50 × $12 = $600).
4. Add them to get COGS: $1,400 + $600 = $2,000.
5. The remaining, older layers are ending inventory: 100 January units (100 × $10 = $1,000) plus 50 March units (50 × $12 = $600) = $1,600.
6. Check the total: $2,000 COGS + $1,600 ending inventory = $3,600, which matches the cost of goods available.

Under FIFO, the same 150 units would give COGS of $1,600 (100 × $10 plus 50 × $12) and ending inventory of $2,000. LIFO shows $400 more in COGS and $400 less in inventory.

This example uses a periodic system, where you calculate COGS at the end of the period. If you update costs after every sale (a perpetual system), LIFO can give different numbers, because the layers available at the time of each sale change the result.

LIFO vs. FIFO: a side-by-side example

To compare the two fairly, give both methods the same facts. A business buys 20 units at $100, then (after prices rise) 40 units at $125. It sells 40 units at $150 each, for revenue of $6,000.

	FIFO	LIFO
Cost of goods sold	20 × $100 + 20 × $125 = $4,500	40 × $125 = $5,000
Ending inventory	20 × $125 = $2,500	20 × $100 = $2,000
Gross profit	$6,000 − $4,500 = $1,500	$6,000 − $5,000 = $1,000

LIFO reports $500 less profit, so it creates $500 less taxable income. FIFO reports the higher profit, and values inventory closer to current costs. When prices are falling, the effect reverses.

What are the benefits of LIFO?

• Lower taxable income when prices are rising. Higher recent costs reduce reported profit, which can reduce your tax bill for the period, and improve cash flow as a result.
• Costs line up with revenue. Your income statement matches current costs against current sales, which can give a better picture of margins when prices move quickly.

These benefits depend on rising costs and on LIFO being permitted where you report. If your costs are flat or falling, LIFO doesn’t reduce your taxes.

LIFO drawbacks and IFRS

• It’s not allowed everywhere. IFRS prohibits LIFO, so businesses reporting under IFRS must use FIFO, weighted average cost, or specific identification. Many countries’ tax authorities don’t accept it either, and your accountant can confirm the rules where you operate.
• Your balance sheet can look out of date. Ending inventory is valued at your oldest costs, which can be well below what it would cost to replace the stock today.
• It’s harder to maintain. You have to keep track of cost layers and, if you report a LIFO reserve, reconcile your figures to a FIFO basis.
• LIFO liquidation can inflate profit. If you sell down your inventory without replacing it, older and cheaper layers flow into COGS, making profit look higher and increasing your tax. In the example above, selling the remaining 150 units without buying more would put just $1,600 into COGS, well below the recent costs of $12 to $14 a unit.
• In the US, tax rules generally require consistency. A business that uses LIFO for tax purposes generally has to use it in its financial reports too, and changing methods needs approval.

Talk to an accountant before choosing or changing a method, because the tax and reporting rules vary and are strict.

Why would anyone use FIFO if LIFO results in lower taxes?

Lower taxes aren’t the only consideration. FIFO is simpler, accepted under both IFRS and US GAAP, and it matches the way most businesses rotate stock, especially with perishable or fast-moving goods. It values inventory closer to current costs, and it reports higher profit, which some businesses want for lenders and investors. And if costs are stable or falling, LIFO has no tax advantage.

How does LIFO affect your financial statements?

When prices are rising, compared with FIFO:

• Income statement: COGS is higher, so gross profit and net income are lower.
• Balance sheet: ending inventory is lower, because it’s valued at older costs.
• Cash flow: your purchase costs are the same under any method, but lower taxable income can mean lower tax payments.

Whichever method you use, the statements should balance. The difference is how costs are split between COGS and inventory. For more on how COGS is calculated, see our guide to cost of goods sold for ecommerce.

When does LIFO make sense?

LIFO tends to suit businesses that report under US GAAP, buy goods whose costs rise over time, hold durable inventory that doesn’t expire, and can handle the extra record-keeping. It’s a poor fit for perishable goods, businesses outside the US, and businesses whose costs are flat or falling. Use the framework in our costing methods guide to compare it with FIFO and weighted average cost. For a simpler alternative, see the weighted average cost method.

FAQs about last-in, first-out (LIFO) inventory costing

Final thoughts

LIFO can reduce your taxable income when costs are rising, but it comes with trade-offs: it’s not allowed everywhere, it understates your inventory value, and it’s harder to maintain. If tax savings are your priority, you operate under US GAAP, and your costs keep rising, it may suit you. If you want simplicity, a balance sheet that reflects current costs, or you report outside the US, FIFO or weighted average cost are usually better.

Accurate stock and order data underpin any costing method. Linnworks inventory management keeps stock levels accurate across every channel you sell on, so the figures going into your accounting are reliable.