Unlike the inventory reporting rules under the International Financial Reporting Standards, or IFRS, the generally accepted accounting principles, or GAAP, do not require companies to use the first-in first-out, or FIFO, method exclusively. American companies are allowed to decide between FIFO or last-in first-out, otherwise known as LIFO, cost accounting.
Under President Obama, the federal government has lobbied to repeal the LIFO standard in the United States. If that takes place, it would be easier for the country to convert to the IFRS system. American companies that have decided to use LIFO must also provide FIFO figures in their financial statement footnotes.
LIFO vs. FIFO
LIFO and FIFO are the two most commonly used inventory accounting methods in the U.S. Switching between methods can affect company valuation, financial statements and tax filing. FIFO is the preferred method outside of the U.S., and there is strong pressure from progressive accounting authorities on the Financial Accounting Standards Board, or FASB, to adopt IFRS standards.
Under the FIFO system, the first unit of a piece of inventory is assumed to be the first to come off of the shelves. Consider a company that makes toy cars. Input costs are not fixed over time, so the first 100 toy cars may cost $10 to make while the last 100 might cost $12. According to the FIFO method, the cost of goods sold, or COGS, for the first sales is $10.
Under a LIFO system, the first sales are associated with a $12 COGS. This has a significant impact on ending inventory on the balance sheet. The reason the LIFO system is controversial is that the last items in inventory tend to age and could potentially become obsolete.
Under GAAP, companies have a choice as to which inventory valuation system is the most advantageous for reporting purposes. This is not the case with the IFRS method, where all companies are locked into FIFO.