Connect to Lesson 2's ambiguity and introduce FIFO and LIFO as two standardized solutions
One Inventory, Two Different Values
In Lesson 2, you discovered that inventory layers create ambiguity. Today, you'll learn how accounting turns that ambiguity into a strategic decision.
Remember Sarah's Client Launch Kits? She started with 10 kits at $18 each, then bought 20 more at $20 each. When she sold 15 kits, you learned that knowing how many units remain (15 kits) doesn't tell you their dollar value.
The same question kept appearing: Which $X should move to Cost of Goods Sold, and which $X should stay in Ending Inventory?
Sarah's bookkeeper told her: "Your ending inventory could be worth either $255 or $285 depending on how you assign costs. Both numbers could be correct."
Sarah's business is growing. She's now offering Premium Client Kits for larger corporate clients. These kits include more resources and sell for higher prices. But they also come with a cost challenge that's even more dramatic than her original kits.
Sarah's Premium Kits This Month:
Sarah sold 20 kits this month at $75 each. But here's the question:Which 20 kits? The $45 ones? The $48 ones? The $52 ones? Or some combination?
Accounting doesn't leave this question unanswered. Over decades, the accounting profession developed four standardized methods for assigning costs when inventory comes from different layers. Today, we'll learn the first two.
FIFO — First-In, First-Out
Assign the oldest costs to COGS first. When you sell products, assume they came from your earliest purchases.
LIFO — Last-In, First-Out
Assign the newest costs to COGS first. When you sell products, assume they came from your most recent purchases.
Coming in Lesson 4: We'll add two more methods —Specific Identification and Weighted Average — to complete your toolkit.
Sarah's Premium Kits are rising in cost — $45, then $48, then $52. This rising-price environment is exactly where FIFO and LIFO produce dramatically different results.
- • Uses older, cheaper costs for COGS
- • Lower COGS → Higher gross profit
- • Higher profit → Higher taxes
- • Higher ending inventory value
- • Looks better to investors and lenders
- • Uses newer, expensive costs for COGS
- • Higher COGS → Lower gross profit
- • Lower profit → Lower taxes
- • Lower ending inventory value
- • Conserves cash by reducing tax burden
The same 20 units sold. The same 10 units remaining.Two different stories about profit, taxes, and asset value. Which one Sarah tells depends on her goals — and today you'll learn how to calculate both.
Discussion Prompt (2 minutes):
If you were Sarah, and you had a meeting with potential investors next month, which method would you instinctively prefer? Why?
Hint: Think about what each method does to your profit numbers. Investors want to see growth and profitability. Does one method make those numbers look stronger?