Teach FIFO and LIFO mechanics with visual layer movement, then explore business consequences
How FIFO and LIFO Assign Costs
Now you'll see exactly how each method works — step by step, layer by layer. Watch how the same inventory produces different results depending on the method you choose.
From Lesson 2, you understand these key concepts:
Physical Flow
How units move on and off the shelf
Cost Flow
Which dollar amounts move from inventory to COGS
Inventory Layers
Groups of units purchased at the same cost
The Lesson 2 question: When you have multiple layers at different costs, which layer's costs should move to COGS when you sell products?
The Lesson 3 answer: FIFO and LIFO are two standardized ways to make that decision.
Both FIFO and LIFO start with the same inventory layers, the same purchases, and the same sales.The only difference is the direction costs flow when calculating COGS.
FIFO: Bottom-Up
Imagine reaching into the bottom of your inventory stack. You pull out the oldest units first. Their costs go to COGS. The newer units stay in inventory.
LIFO: Top-Down
Imagine reaching into the top of your inventory stack. You pull out the newest units first. Their costs go to COGS. The older units stay in inventory.
Interactive FIFO vs. LIFO Demonstration
Work through the visualization below. Click Next to progress through each step. You'll see how inventory layers work, then watch FIFO and LIFO calculate different results from the same transactions.
The Scenario
Sarah's business has 30 Premium Client Kits in inventory from three purchases at different costs. This month, she sold 20 units for $75 each.
Inventory Layers (Stacked like boxes)
Your Task
You'll choose a method (FIFO or LIFO), then manually assign costs to Cost of Goods Sold and Ending Inventory to see how each method creates different financial results.
Mechanics You Learned
- ✓FIFO assigns oldest (cheapest in rising costs) to COGS first
- ✓LIFO assigns newest (most expensive in rising costs) to COGS first
- ✓Both methods use the same inventory layers and same sales
- ✓The difference is purely about cost assignment, not physical units
Business Consequences You Saw
- ✓In rising-cost environments, FIFO shows higher profit and higher taxes
- ✓In rising-cost environments, LIFO shows lower profit and lower taxes
- ✓Investor presentations might favor FIFO for stronger numbers
- ✓Tax planning might favor LIFO for cash conservation
Important: The method you choose doesn't change what actually happened in Sarah's business. It only changes how she reports it. The physical units sold are the same — the difference is purely in the accounting presentation.
Now that you've seen how FIFO and LIFO work visually, you'll practice building the calculations yourself. In Guided Practice, you'll work through layer assignments step by step, then compare your results to see which method fits different business situations.