Inventory valuation can be done using a choice of methods The biggest choice is between FIFO and LIFO and this is a choice that American companies need to make LIFO is not allowed under international financial reporting standards but it is allowed under U.S. GAAP So what is FIFO and LIFO? Well FIFO stands for "First In First Out" and LIFO stands for "Last In First Out" FIFO means that the first inventory that we receive Maybe I received some inventory a week ago then 3 days ago, then I received some inventory today Well I decide that the first ones that came in, that must be the first that goes out So if I sell a unit today, I will decide that that's the unit from one week ago LIFOs the opposite, LIFO says the last one that came in is the first to go out So the inventory that I maybe bought today is also the inventory that I sell today Now this can affect the inventory valuation i.e. the inventory that's left over after that sale If we think that it affects the value of inventory that's been sold Then that can affect the value of COGs or cost of goods sold If the unit that I decide to sell is quite highly valued (it cost me a lot to buy) then my COGs will be quite high, my net income quite low Alternatively if the unit that I decide to sell is actually quite cheap then my COGs will be cheap and my net income will be really high This also affects the inventory that's unsold and that's left over If I sold a unit that was very expensive this could mean that I end up with much cheaper units left over So I now have a very small inventory Let's see an example Here we've got a company that's made purchases over three days, day 1, 2 and 3 Each time they purchase one unit but the cost has been going up On day one the cost is 5 On day two, the cost is 7 and on day three the cost is 9 The company now comes to sell them, the company now comes to sell one of those units If we look at FIFO first and one unit is sold, then FIFO would say that we must sell the first item that came in i.e. the unit that came in on day one and that cost us 5 Because the price was very cheap then, then this means that my COGs is very low at 5 The inventory left over must be the more expensive items (the 7 plus the 9), giving me total inventory of 16 However, if the company had chosen to use LIFO Then instead it must be the last item that came in that was the first that went out really So it's the item that purchased on day three That item cost me 9 which means my COGs (cost of goods sold) must be 9 And my inventory is instead the cheaper items, the 5 and the 7 By comparing these two methods, we can see that the COGs have varied from 5 up to 9 and the inventory has varied from 16 all the way down to 12 A handy way to remember these, is when in an inflationary environment (which is most countries) and which is in this example where costs are going up over time Then the LIFO will give you a low inventory value. So the "LI" of LIFO, hopefully will help you remember low inventory Now companies aren't allowed to just switch between FIFO and LIFO at will or for every that is sold But they can do it once in awhile and this can make a big change to company's accounts So particularly if you're in the U.S, it's something to just be aware of But it's not a commonly seen thing