LIFO vs FIFO Inventory Valuation Method: Differences Overview

March 7, 2025

The heavy construction industry determines value in every dollar it spends on fuel maintenance and spare parts needed to keep machinery operational.

Business operations typically spend little time considering a critical inventory management aspect that pertains to stock valuation methods.

The inventory valuation methods LIFO and FIFO bring significant changes to financial reporting as well as tax obligations while affecting overall profitability.

Companies that handle equipment fleets along with attachments and spare parts need to understand these methods because they directly optimize financial flow and create better purchasing choices.

This article breaks down how FIFO and LIFO inventory methods affect your financial statement and explores their profitability effects for modern construction companies.

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What is FIFO?

First-In, First-Out (FIFO) represents an inventory valuation system which applies the principle of using previously stored products first so new inventory stays undisturbed until necessary.

The system focuses inventory flow to minimize waste while extending product freshness and reducing obsolete material risk especially for construction supply and component and perishable product industries.

When implemented as a valuation method FIFO matches the actual movement of inventory that occurs within most business operations.

As prices increase over time FIFO produces reduced cost of goods sold therefore companies report higher net profits that affect their tax liabilities.

Employees using FIFO receive better inventory valuation accuracy which improves both efficiency assessment and financial stability monitoring.

Businesses focus on maintaining their inventory supply chain most effectively by using FIFO because these organizations value efficient stock rotation and accurate cost tracking and enduring product lifetime.

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What is LIFO?

Inventory valuation with LIFO strategy uses the most recent items acquired as the basis for first material usage thereby keeping older stored products inactive.

The inventory valuation method proves most beneficial in industries where products have indefinite shelf life such as the construction equipment sector.

The application of LIFO in inflationary markets helps businesses lower their taxable income by using current higher-priced inventory as cost of goods sold (COGS).

Using LIFO may cause existing inventory to stay dormant too long thus creating potential inefficiencies unless managers maintain proper oversight.

Businesses with tax reduction goals and cash flow and cost matching needs typically choose the LIFO accounting method specifically to handle market price changes of long-term assets and continual material expenses.

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Understanding the Inventory Formula

Financial reporting greatly depends on inventory valuation while the ending inventory formula determines remaining stock levels at financial period ends.

Beginning Inventory + Purchases = Goods Available for Sale – Cost of Goods Sold (COGS) = Ending Inventory

To put it simply, a company starts with an initial stock of goods, adds new purchases throughout the period, and then subtracts the number of items sold to determine what remains in inventory.

For an instance; a construction equipment supplier begins the month with a stock of 30 hydraulic pumps.

The company makes a second purchase of 100 pumps throughout the month which yields a total goods available for sale of 130 units.

The company possesses 50 pumps as ending inventory when they sell 80 pumps.

The inventory valuation system combines two methods known as FIFO and LIFO at this point.

The methods used for inventory valuation decide which costs become part of COGS or stay in inventory position thus affecting both financial statements and the balance sheet column.

The finance results and cost determination under FIFO differ from those of LIFO since FIFO starts with inventory that has been in storage the longest but LIFO starts with fresh inventory.

Businesses need to understand these methods especially in industries with material cost fluctuations since their selection affects profitability and taxation and financial strategy.

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LIFO vs. FIFO: Similarities & Differences

Category	LIFO (Last-In, First-Out)	FIFO (First-In, First-Out)
Similarity	Inventory Valuation Method	Newest stock is used/sold first; oldest stock remains.
Cost of Goods Sold (COGS) Calculation	Uses most recent inventory costs, leading to higher COGS in inflation.	Uses older inventory costs, leading to lower COGS in inflation.
Impact on Net Income	Results in lower reported profits in inflationary periods.	Results in higher reported profits in inflationary periods.
Taxation Impact	Lower profits mean lower tax liability in inflation.	Higher profits mean higher taxes in inflation.
Financial Reporting Standards	Allowed under GAAP, but not permitted under IFRS.	Accepted under both GAAP and IFRS.
Inventory Flow Assumption	Assumes that the newest inventory is sold first, even if not physically.	Assumes that the oldest inventory is sold first, regardless of actual movement.
Effect on Balance Sheet	Older inventory stays on the books, leading to understated inventory values over time.	Inventory value reflects current market prices more accurately.
Impact on Cash Flow	Can improve cash flow during inflation by reducing tax burdens.	Higher taxes may reduce available cash flow in inflation.
Suitability by Industry	Best for non-perishable goods, such as construction materials, machinery parts, and raw materials.	Best for perishable/time-sensitive items, like food, pharmaceuticals, and consumer goods.
Use During Deflation	Can lead to higher taxable income as COGS decreases.	Results in lower taxable income since older, cheaper stock is sold.
Effect on Gross Margin	Lower margins due to higher costs of goods sold.	Higher margins due to lower costs of goods sold.
Inventory Turnover & Waste Management	Risk of older inventory becoming obsolete or unsellable.	Ensures older stock is sold first, reducing the risk of waste.
Adoption by Businesses	Used by companies aiming to reduce taxable income during inflation.	Used by businesses prioritizing accurate inventory valuation and financial clarity.

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Pros and Cons of FIFO and LIFO

Category	FIFO (First-In, First-Out)	LIFO (Last-In, First-Out)
Financial Reporting Accuracy	Provides a more accurate inventory valuation, as ending inventory reflects current market prices.	Can result in outdated inventory values on the balance sheet, as older inventory remains.
Tax Impact in Inflation	Higher taxable income, as older, cheaper inventory is recorded as COGS, increasing reported profits.	Lower taxable income, as newer, higher-cost inventory is recorded as COGS, reducing profits and taxes.
Tax Impact in Deflation	Lower taxable income, as cheaper inventory is recorded as COGS, reducing profits.	Higher taxable income, as newer, lower-cost inventory is recorded as COGS, increasing profits.
Accepted by Accounting Standards	Accepted under GAAP and IFRS, making it globally applicable.	Allowed under GAAP but not permitted under IFRS, limiting its use outside the U.S.
Suitability by Industry	Ideal for businesses handling perishable goods or items with expiration dates (e.g., food, pharmaceuticals).	Best for industries with non-perishable or high-cost inventory, such as construction, oil, and manufacturing.
Impact on Profitability in Inflation	Higher COGS results in lower gross margin and lower profits during inflation.	Higher COGS results in higher gross margin and higher profits during inflation.
Impact on Balance Sheet	Ending inventory is valued at recent, higher costs, providing a realistic asset valuation.	Ending inventory is valued at older, lower costs, making assets appear undervalued over time.
Inventory Management	Ensures older stock is sold first, reducing waste and obsolescence.	Can lead to outdated or obsolete inventory sitting in storage, increasing holding costs.
Impact on Cost of Goods Sold (COGS)	Lower COGS in inflationary times (as older, cheaper inventory is sold first).	Higher COGS in inflation, leading to tax savings.
Profit Stability Over Time	Provides a more consistent and predictable profit margin over time.	Profit margins can fluctuate significantly based on inventory costs and inflation trends.
Cash Flow Considerations	May result in higher tax payments, reducing available cash flow.	Lower taxable income means more cash flow available for reinvestment.
Real-Life Inventory Flow	Matches actual inventory movement in most businesses.	Rarely reflects actual inventory movement, as companies do not sell the newest stock first.

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3 Major Inventory Challenges for Construction Companies

Running inventory control in the construction field proves a complex task.

Three main factors including supply chain disruptions and fluctuating material costs and project-based purchasing influence the industry's complexity levels.

Maintaining important material inventories helps delay project delays but creates both financial and tax-related difficulties.

Three main inventory challenges exist which construction companies need to handle.

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Do you know?

48% of businesses are revaluating their warehouse locations due to shifting trade patterns resulting from changes in the US economy: taxes, tariffs, and the return of manufacturing.

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1. Inventory Valuation

image showing Inventory Valuation on laptop screen

The valuation technique for constuction inventory management determines both financial statement reporting and tax liability.

A construction company's inventory valuation affects Cost of Goods Sold computation thus influencing both financial expenses and tax obligations.

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2. Shrinkage

image showing woman worker looking on inventory material

Shrinkage of inventory manifests from theft alongside damage and fraud and subpar managerial practices.

Shrinkage presents a costly problem in construction sites since they store high-value materials including steel, copper and lumber.

Financial records become affected through shrinkage due to both direct material losses and indirect monetary impacts.

Proper inventory accounting of missing materials is necessary to avoid distorting inventory value and profit reports and tax obligations.

Tracking inventory losses with IRS standards requires businesses to survive audits on a regular basis.

To mitigate shrinkage, construction companies should:

An organization must put into effect strict inventory controls with both real-time tracking features and access restriction protocols.

The organization needs to strengthen security systems through video monitoring cameras together with protected storage areas and anti-theft procedures.

The physical count of inventory should be conducted on a regular basis for double-checking stock levels with record data.

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3. State and Local Taxes

image showing hand on helmet with some cash on table

Many states and municipalities impose inventory taxes, sales and use taxes, or property taxes on stored materials.

For construction companies operating across multiple locations, compliance can be a logistical challenge.

Inventory tax: Some states tax inventory as part of property assessments, meaning materials held at the end of a fiscal year can increase tax liabilities.

Sales and use tax: Varying tax rates on materials purchased and stored in different jurisdictions can create accounting complexities.

To minimize tax burdens, construction companies should:

Track where inventory is stored and for how long.

Shift materials strategically to locations with lower or no inventory tax when possible.

Time purchases and transfers to optimize tax positioning.

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Bottomline

Inventory management systems determine the success levels that construction companies achieve.

Using FIFO or LIFO affects both financial statements and tax liabilities as well as it affects company profits.

Using FIFO maintains accurate inventory valuation together with waste reduction benefits companies but LIFO becomes beneficial for tax purposes during times of inflation.

Companies need to handle three primary inventory issues besides their selection of valuation methods since these problems include inventory shrinkage and state and local tax compliance requirements along with financial consequences that stem from how they manage their inventory.

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