LIFO explained, and why IFRS does not allow it

LIFO is a uniquely American accounting method that survives because of tax law. It can save companies significant cash tax when prices rise, but it leaves out-of-date costs on the balance sheet. This guide explains how LIFO works, the LIFO reserve and LIFO liquidations, and why IFRS does not allow it.

By Hamza Fida, Chartered Accountant. Reviewed by Mirza Fahad Baig, Chartered Accountant. 3 minute read.

Short answer

LIFO, or last-in, first-out, is an inventory cost flow assumption that charges the most recently purchased units to cost of goods sold, leaving the oldest costs in inventory. When prices rise, LIFO gives higher cost of goods sold, lower profit and lower taxable income than FIFO. US GAAP allows LIFO and US tax law requires a company using LIFO for tax to use it in its financial statements too, the LIFO conformity rule. IFRS prohibits LIFO. In this guide's example, the LIFO reserve, the difference between FIFO and LIFO inventory, is $450.

At a glance

Charges to cost of sales
Newest costs first
Rising prices
Higher cost of sales, lower tax
LIFO reserve
FIFO inventory less LIFO inventory
Conformity rule
LIFO for tax requires LIFO for books
LIFO liquidation
Old, cheap layers boost profit
IFRS
Prohibited
LIFO explained, and why IFRS does not allow itCharges to cost of sales: Newest costs first; Rising prices: Higher cost of sales, lower tax; LIFO reserve: FIFO inventory less LIFO inventory; Conformity rule: LIFO for tax requires LIFO for books; LIFO liquidation: Old, cheap layers boost profit; IFRS: Prohibited.KEY FACTS AT A GLANCELIFO explained, and why IFRS does not allow itCharges to cost of salesNewest costs firstRising pricesHigher cost of sales,lower taxLIFO reserveFIFO inventory less LIFOinventoryConformity ruleLIFO for tax requiresLIFO for booksLIFO liquidationOld, cheap layers boostprofitIFRSProhibitedTax BakersLIFO explained, and why IFRS does not allow itCharges to cost of sales: Newest costs first; Rising prices: Higher cost of sales, lower tax; LIFO reserve: FIFO inventory less LIFO inventory; Conformity rule: LIFO for tax requires LIFO for books; LIFO liquidation: Old, cheap layers boost profit; IFRS: Prohibited.KEY FACTS AT A GLANCELIFO explained, and why IFRS doesnot allow itCharges to cost of salesNewest costs firstRising pricesHigher cost of sales, lower taxLIFO reserveFIFO inventory less LIFO inventoryConformity ruleLIFO for tax requires LIFO for booksLIFO liquidationOld, cheap layers boost profitIFRSProhibitedTax Bakers
Key facts at a glance, as set out in this guide.

How does LIFO work?

A distributor starts the year with 100 units at $10 and buys 200 at $11, 300 at $12 and 100 at $13. It sells 450 units at $20.

$FIFOLIFO
Revenue9,0009,000
Cost of goods sold5,000 (oldest units first)5,450 (newest units first)
Gross profit4,0003,550
Closing inventory (250 units)3,1002,650
FIFO vs LIFO with rising prices ($)FIFO vs LIFO with rising prices ($)5,0005,450Cost of goods sold4,0003,550Gross profit3,1002,650Closing inventoryFIFOLIFO
LIFO lowers profit and inventory by the change in the LIFO reserve, $450 here.

LIFO reduces gross profit by $450, and at a 21% tax rate saves $94.5 of tax this year. The closing LIFO inventory carries the oldest costs, $10 and $11 a unit, while current costs are $13.

What is the LIFO reserve?

The difference between inventory measured on FIFO, or current cost, and inventory measured on LIFO: $3,100 - $2,650 = $450 here. Public companies using LIFO disclose it, and analysts add it back to compare LIFO companies with FIFO or IFRS companies. The change in the reserve during the year is the difference between FIFO and LIFO cost of goods sold. After decades of inflation, some companies' LIFO reserves run into billions of dollars.

What is a LIFO liquidation?

When a LIFO company sells more units than it buys, it dips into older inventory layers carrying old, low costs. Cost of goods sold falls and profit, and taxable income, rise, even though nothing changed economically. Companies disclose the effect of material LIFO liquidations, and managing year-end purchases to avoid them is a long-standing practice.

What is the LIFO conformity rule?

US federal tax law allows a company to use LIFO for tax only if it also uses LIFO in its primary financial statements to shareholders and creditors. That is why LIFO survives in US GAAP: removing it would force many companies off LIFO for tax and trigger tax on their accumulated LIFO reserves. Supplemental non-LIFO information can be disclosed in the notes.

What is dollar-value LIFO?

Most LIFO companies do not track individual units. Dollar-value LIFO groups inventory into pools and measures layers in dollars adjusted by price indexes, which simplifies the calculation and reduces liquidations when the product mix changes.

Can a company switch to or from LIFO?

Adopting LIFO for tax requires filing with the IRS and, because of the conformity rule, using LIFO in the financial statements from the same year. Leaving LIFO is a change in accounting principle under US GAAP that must be justified as preferable, applied retrospectively, and usually triggers tax on the accumulated LIFO reserve, spread over a few years. That tax cost is why few companies leave LIFO voluntarily.

Why does LIFO matter more when inflation is high?

The faster prices rise, the bigger the gap between the newest costs charged to cost of goods sold and the oldest costs left in inventory. In years of high inflation, LIFO companies report noticeably lower profits and pay less tax than FIFO peers, and their LIFO reserves grow quickly.

Why does IFRS prohibit LIFO?

The difference matters most for retailers and distributors; see retail accounting.

The IASB removed LIFO from IAS 2 in 2003 because it does not reflect the actual physical flow of goods for most businesses and leaves inventory on the balance sheet at outdated costs. See IAS 2 vs ASC 330, FIFO vs weighted average and ASC 330 explained. The Inventory costing comparison (Excel) shows FIFO, weighted average and LIFO side by side.

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Questions people ask

What is LIFO?

Last-in, first-out: an inventory method that charges the most recent costs to cost of goods sold, leaving the oldest costs in inventory.

What is the LIFO reserve?

The difference between inventory valued on FIFO or current cost and inventory valued on LIFO.

Why is LIFO not allowed under IFRS?

Because it does not reflect the actual flow of goods for most businesses and leaves inventory at outdated costs.

What is the LIFO conformity rule?

A US tax rule allowing a company to use LIFO for tax only if it also uses LIFO in its financial statements.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. FASB Accounting Standards Codification: Topic 330, Inventory
  2. Financial Accounting Standards Board

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

ASC 330ASC 330 inventory explainedIFRS vs US GAAPIAS 2 vs ASC 330: inventory, LIFO and write-downsIAS 2Cost formulas: FIFO and weighted average

More in ASC 330

Previous in this topicLower of cost and net realizable valueTopicAll 3 guides in ASC 330

This guide is general information. It is not tax or legal advice for your situation.