Most business owners know two inventory methods: First In, First Out (FIFO) and Last In, First Out (LIFO). Both drive cost of goods sold, taxable income, and the inventory value on your balance sheet. But what about goods that spoil or carry expiration dates? Two more methods should be considered: First Expired, First Out (FEFO) and weighted average costing. Let’s walk through each method.
FIFO accounting, or First In First Out, proceeds on the logical assumption that a business sells its inventory in the order it was purchased. For example, you purchase 25 cases of synthetic oil on January 5, then purchase another 20 cases on February 5. If then you sell 18 cases, those 18 cases are at the cost of the January 5 supplier price and so will the next 7 cases you sell.
LIFO accounting, or Last In First Out, assumes that a business sells its inventory in the reverse order it was acquired. In our synthetic example, once the February load of 20 cases arrived on the dock, the next 20 sales would be at the February 5 product cost. Upon sale of case number 21, the cost would be based upon the January product cost.
FEFO accounting, First Expired, First Out, is an inventory method where goods with the earliest expiration date are sold or used first, regardless of when they arrived. This method is primarily used for perishable goods, and the purpose is to reduce waste and get products to customers before it expires. Furthermore, we must distinguish that FEFO methodology is a physical counting process and not an inventory valuation method. Therefore, your convenience store or warehouse could use FEFO to determine which good to sell next due to expiration, but the accounting department utilizes LIFO or FIFO for inventory valuation. Finally, FEFO is not an IRS or GAAP recognized accounting method, reflected in IRS Publication 538 01/2022 and ASC 330, but could be considered a ‘specific identification’ method and potentially acceptable. Before using this methodology, consult your CPA.
For a very simple example, picture ABC Convenience Store, holding 500 units of a refrigerated product at $8 per unit, with 100 units nearing expiration. Left unsold, that batch becomes an $800 write-off, saving roughly $320 in taxes at a 40% rate, but only after losing the full $800 investment: a net cash loss of about $480. Sell the same batch before it expires, at $15 per unit, $1,500 in revenue against the same $800 cost, $700 profit, about $280 in tax, roughly $420 in after-tax cash. That’s a nearly $900 cash flow swing on the same 100 units, driven entirely by timing, not costing method.
Weighted Average Cost accounting blends every unit in inventory into one average cost per unit, recalculated as new purchases arrive, rather than tracking which specific units sold. It suits commodity-like goods where tracking individual purchases isn’t worth the effort, and it smooths the swings FIFO and LIFO produce when prices are volatile.
Take XYZ Convenience Store, buying packaged goods: 100 units at $10, then 100 more at $12. Sell 150 units, and weighted average blends everything to an $11 cost, putting COGS at $1,650. FIFO would cost those units at $1,600; LIFO at $1,700. At a 40% tax rate, that $100 spread between FIFO and LIFO is worth about $40 in taxes. Weighted average lands almost exactly halfway between the two, a middle ground rather than the largest possible deferral in either direction.
| Method | Pros | Cons |
| FIFO | Matches how most goods actually move; intuitive and easy to explain; can produce higher reported profit and inventory values, which can help with loans/financing | Higher reported profit usually means higher taxable income |
| LIFO | Can potentially lower taxable income; may improve cash flow via lower tax bills | Not permitted if reporting internationally; potentially more complex recordkeeping; difficult to unwind once elected |
| FEFO | Good for perishable goods; supports food safety and quality goods | Not an IRS or GAAP recognized costing method; governs physical flow not the dollar figure; still requires a recognized costing method; must have a solid tracking system |
| Weighted Average Costing | Simple to maintain, smooths out price swings, less recordkeeping than tracking individual items | Doesn’t reflect actual cost of specific units sold, sits between LIFO and FIFO tax outcomes |
How Often Can You Switch Methods?
Inventory costing isn’t a setting you toggle yearly to chase the best tax outcome. Changing methods requires filing IRS Form 3115, Application for Change in Accounting Method. As a general rule, once you change your inventory costing method, you can’t change it again for five years. There is more to this rule than meets the eye, so speak with your CPA before filing.
Can You Use Different Methods for Different Products?
The IRS doesn’t require one method across every product line. A wholesaler can value finished goods under FIFO while valuing raw materials under weighted average, provided each category’s method is applied consistently within that category, year-over-year. The constraint is consistency within each pool of goods, not uniformity across the whole business, just remember it brings in another layer of complexity. Any change still triggers the same Form 3115 process. Given what’s riding on the choice it’s worth deciding alongside your CPA.
Tools Beyond the Spreadsheet
Excel works for a handful of SKUs, but it won’t flag an expiring lot, reconcile a physical count, or catch a formula error before it throws off COGS. If you need more horsepower than a spreadsheet can offer, two technologies worth exploring are PDI technologies and ADD Systems. Meridian does not endorse any software providers, but these two software technology companies are EMA Platinum Corporate Partners.
The inventory costing method you’re using right now was likely chosen years ago, maybe for reasons that no longer apply to your business. The next time you sit down with your CPA or your finance team, it’s worth revisiting that choice. Ask two things: First, is your current method costing you more in taxes than it needs to, given how your prices and inventory have moved? Second, does it still fit where the business is headed? The method itself rarely makes or breaks a business, but going years without asking the question can quietly cost real money.
