Accounting

Inventory Costing Methods Compared: FIFO, LIFO, Weighted Average

Choosing among FIFO, LIFO, and weighted-average affects your gross margin, taxable income, and balance sheet — here's how to pick the right method.

By Aparna Devalla, CPA3 min · 5 slidesUpdated June 15, 2026

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Different costing methods produce materially different COGS, gross margin, taxable income, and inventory balance sheet values.
The right method depends on: business type, inflation environment, lender expectations, tax planning goals, IFRS or GAAP requirements.
Once chosen, changing methods requires Form 3115 (Change in Accounting Method) and IRS approval. Don't change casually.

Assumes the first units purchased are the first sold. COGS reflects older (typically lower-cost) inventory; ending inventory reflects newer (typically higher-cost).
In an inflationary environment: COGS is lower, gross margin is higher, taxable income is higher, ending inventory is higher.
Most common method in U.S. SMB manufacturing and retail.
Matches physical flow for perishable inventory (food, pharmaceuticals).
Required under IFRS — companies with international stakeholders or potential acquisitions abroad should prefer FIFO.

Assumes the last units purchased are the first sold. COGS reflects newer (typically higher-cost); ending inventory reflects older (typically lower-cost).
In an inflationary environment: COGS is higher, gross margin is lower, taxable income is lower (tax-deferral benefit), ending inventory is lower.
Rare in SMB. Common in petroleum, certain manufacturing.
Forbidden under IFRS — only legal under U.S. GAAP.
LIFO reserve must be tracked separately. Liquidation of old LIFO layers in shrinking inventory creates surprise taxable income.

Service business with no inventory: not applicable.
Retail with low inventory turnover: FIFO matches physical flow.
Manufacturing with steady prices: weighted average is simplest.
Manufacturer or distributor with high inflation: LIFO provides tax deferral but creates complexity.
Business preparing for acquisition or international expansion: prefer FIFO for IFRS compatibility.
Need help choosing or switching methods? Rubric Financial includes inventory costing setup and method-change planning (Form 3115) in accounting engagements.

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