LIFO Inventory — Smart Financial Analysis

📚 Official Sources

📖 How LIFO Works

LIFO matches the most recent purchase costs to revenue. When prices rise, this increases COGS and reduces reported profit. The LIFO reserve (FIFO inventory minus LIFO inventory) measures cumulative tax deferral.

⚖️ LIFO vs FIFO in Inflation

In rising prices: LIFO COGS > FIFO COGS → LIFO profit < FIFO profit → LIFO taxes < FIFO taxes. In deflation, the opposite occurs — LIFO can produce lower COGS than FIFO.

💰 LIFO Tax Advantage

Tax savings = (LIFO COGS - FIFO COGS) × Tax Rate. Companies in high tax brackets with rising inventory costs benefit most. Oil & gas, automotive, and construction industries have high LIFO adoption.

⚠️ LIFO Liquidation Risk

When inventory drops below prior-year levels, old LIFO layers are "liquidated." Selling inventory bought at $10 when replacement cost is $50 creates $40/unit of taxable income — a tax bomb. Companies often buy inventory before year-end to avoid liquidation.

📐 LIFO Formula

COGS = Σ (units sold from each layer × cost per unit), starting with the most recent layer. Ending inventory = oldest layers remaining.

🌍 LIFO Under IFRS

LIFO is not permitted under International Financial Reporting Standards (IFRS). Companies reporting under IFRS must use FIFO or weighted average cost. US-only companies can elect LIFO for both tax and GAAP reporting.

📋 LIFO Conformity Rule

IRC Section 472 requires that if you use LIFO for federal income tax, you must use LIFO for your annual financial statements. No mixing LIFO for taxes with FIFO for reporting.