Yes, FIFO is allowed under US GAAP. First-in, first-out is one of four inventory cost flow methods recognized by Accounting Standards Codification (ASC) 330, alongside LIFO, weighted-average cost, and specific identification. It is the most common choice among U.S. companies because it mirrors the physical movement of goods in most industries and leaves ending inventory valued at recent costs.
The specific authority sits in ASC 330-10-30-9, which lists the permitted cost flow assumptions. Under FIFO, the units you bought or produced first are treated as the units you sold first. Whatever remains on the shelf at period-end carries the cost of your most recent purchases. The IRS accepts the same method for federal tax purposes, defining it as the assumption that “items you purchased or produced first are the first items you sold, consumed, or otherwise disposed of.”1Internal Revenue Service. Publication 538, Accounting Periods and Methods
The Four Methods GAAP Permits
GAAP does not force every company into the same costing approach. You can choose among four:
- FIFO (first-in, first-out): oldest costs hit cost of goods sold first; ending inventory reflects recent prices. Well suited to perishable goods and short shelf lives.
- LIFO (last-in, first-out): newest costs hit cost of goods sold first. During inflation this lowers reported profit and defers taxes, but leaves stale cost layers on the balance sheet. Permitted under U.S. GAAP but not under international standards.
- Weighted-average cost: all units in a pool share one blended cost. Works for bulk commodities like fuel or chemicals where individual units are indistinguishable.
- Specific identification: each unit carries its own actual cost. Practical only for high-value, individually tracked items such as jewelry or custom machinery.
During periods of rising prices, FIFO reports higher gross profit and higher ending inventory than LIFO would for the same goods. That difference flows through to taxable income, which is the main reason some companies still choose LIFO despite its messier balance sheet.
What Goes Into a FIFO Cost Layer
The “cost” you assign to each layer is not just the supplier’s invoice price. It includes every expenditure needed to bring the goods to their current location and condition. For purchased items, that means the purchase price plus freight, transit insurance, and handling fees incurred before the goods reach your warehouse.
Manufacturers add more. Direct materials, direct labor, and a share of factory overhead all get folded into the cost of each unit produced. Overhead allocation typically covers equipment depreciation, factory rent, and utilities tied to the production floor. Administrative salaries and selling expenses stay off the inventory line and hit the income statement as period costs.
FIFO then organizes those fully loaded costs into chronological layers. Receive 500 units at $8 in January and 500 more at $9 in March, and the January layer flows to cost of goods sold first. Once those 500 are gone, the March layer starts flowing. Tracking layers accurately is the core operational demand of the method, and it drives the ending inventory number that lands on the balance sheet.
The Lower of Cost or Net Realizable Value Ceiling
Setting up FIFO cost layers is only half the job. GAAP caps inventory values through the lower of cost or net realizable value (LCNRV) rule in ASC 330-10-35. FASB simplified this test in Accounting Standards Update 2015-11, which replaced the older “lower of cost or market” test for companies that do not use LIFO.2Financial Accounting Standards Board. ASU 2015-11
Net realizable value is what you expect to sell the goods for in the ordinary course of business, minus any estimated costs to complete and sell them. If that figure falls below what you paid, you write the inventory down to the lower amount and recognize the difference as a loss in the current period. Inventory carried at $5,000 under FIFO that can only fetch $4,200 after selling costs triggers an $800 write-down right away.
The comparison runs at the end of every reporting period. The purpose is conservatism. An overstated inventory line inflates both total assets and gross profit at the same time, which is why auditors focus on this test.
Disclosure and Consistency
Picking FIFO is not the end of it. The notes to your financial statements must disclose your inventory costing method so readers know whether the inventory figure reflects FIFO layers, LIFO layers, or an average. Without that disclosure, comparisons across companies fall apart.
ASC 250 also establishes a presumption that an accounting principle, once adopted, should not be changed. Consistent use from period to period lets readers track gross margin and inventory turnover without wondering whether a method switch is distorting the trend. On the income statement, FIFO drives cost of goods sold and therefore gross profit. On the balance sheet, ending inventory shows up as a current asset. Flipping methods between periods would make both lines unreliable.
The Tax Consequence and the LIFO Conformity Rule
FIFO’s reporting advantages come with a tax trade-off. Because FIFO expenses the oldest, cheapest inventory first, it produces a lower cost of goods sold in inflationary periods. Lower cost of goods sold means higher gross profit and higher taxable income.1Internal Revenue Service. Publication 538, Accounting Periods and Methods
Businesses that want LIFO’s tax deferral face a constraint worth knowing before you make any choice. Under the LIFO conformity rule in 26 U.S.C. § 472(c), a company that elects LIFO for its federal tax return must also use LIFO in financial statements issued to shareholders, partners, or creditors.3Office of the Law Revision Counsel. 26 U.S. Code 472 – Last-in, First-out Inventories You cannot run LIFO on the tax return and FIFO on the annual report. That one-way lock is a large part of why many companies keep FIFO across both.
Changing to or From FIFO Later
The consistency presumption is not an absolute bar. ASC 250-10-45-2 allows a change in inventory method if management can show the new method is “preferable,” meaning it improves financial reporting rather than just lowering taxes. The analysis looks at whether the new method better matches costs to revenues, more accurately reflects assets, and aligns with prevalent industry practice. For SEC registrants, the independent auditor must submit a letter confirming preferability, and auditors will push back if the rationale looks like income smoothing.
On the tax side, you file Form 3115 to request a change in accounting method.4Internal Revenue Service. Instructions for Form 3115 The form triggers a Section 481(a) adjustment so income is neither duplicated nor skipped during the transition. Companies switching from LIFO to FIFO after sustained price increases often face a large positive adjustment, because the old LIFO layers held artificially low costs that now need to catch up.
Switching away from LIFO also drags in the conformity rule from the other direction. Under 26 U.S.C. § 472(e)(2), the IRS can revoke a company’s LIFO election if it detects a non-LIFO method in reports to shareholders or creditors.3Office of the Law Revision Counsel. 26 U.S. Code 472 – Last-in, First-out Inventories Any move off LIFO has to be coordinated across financial reporting and tax filings at the same time.