What is the key difference between LIFO and FIFO inventory accounting methods?

The key difference between LIFO (Last In, First Out) and FIFO (First In, First Out) inventory accounting methods lies in how they manage the cost of goods sold (COGS) and the value of inventory. Under FIFO, the oldest inventory items are considered sold first. This means that the cost of the older items in stock is recorded as the cost associated with the sales that occur during the period.

When using FIFO in an environment of rising prices, the COGS will reflect these older, lower costs, which can lead to higher reported profits and potentially increased tax liability, as the remaining inventory will be valued at a higher price. Consequently, FIFO often results in a higher taxable income compared to LIFO during inflationary periods.

In contrast, LIFO assumes that the most recently purchased items are sold first. This approach results in COGS being based on the newer, often higher-cost inventory, leading to lower taxable income during periods of rising costs.

Thus, the statement affirming that FIFO uses the oldest inventory for COGS accurately captures the defining feature of this accounting method, highlighting the core distinction between FIFO and LIFO and its implications for financial reporting and taxation.