Costs and benefits of the LIFO‐FIFO choice

Abstract The choice of inventory cost flow assumption is a key financial reporting decision. The resurgence of inflation has renewed interest in this option. We derive algebraic models of the LIFO‐FIFO difference in cost of goods sold and the LIFO tax savings as a function of inflation, turnover, inventory increments, and tax rates. Managers and researchers can use these models to estimate the likely financial and tax impacts of LIFO adoption. Historic trends in public company LIFO usage since 1971 are consistent with the changing impacts estimated by our model. We infer an approximate cost level of using LIFO based on historic public company behavior. In the 1971–2022 period, LIFO adoptions were only common when the tax benefit in our model exceeded about 0.35% of COGS. Even when inflation rose in 2021 and 2022, the tax savings remained below this threshold, and there were far more LIFO abandonments than adoptions.