The Short Answer
FIFO and LIFO are two ways of deciding what your unsold stock cost you.
- FIFO (first in, first out) assumes the oldest stock is sold first. Whatever is left at the year end is valued at the most recent purchase prices.
- LIFO (last in, first out) assumes the newest stock is sold first. Whatever is left is valued at the oldest prices.
- Weighted average cost (AVCO) ignores the order and values every unit at the average price paid.
In the UK you can use FIFO or weighted average. LIFO is not allowed, either in accounts prepared under UK GAAP or for tax. Most of the FIFO vs LIFO content online is American, where LIFO is still legal, and that is where most of the confusion starts.
The method only changes how you split the same total cost between cost of sales and closing stock on the balance sheet. It does not change what you spent, and over the life of the business it does not change your total profit. It changes the timing.
Why the Valuation Method Matters at All
Your stock figure feeds straight into profit. The cost of sales formula is:
Cost of sales = opening stock + purchases − closing stock
Purchases are what they are. Opening stock is last year's closing figure. So the only number you have any judgement over is closing stock, and every pound added to it is a pound less in cost of sales and a pound more in gross profit.
If every unit you ever bought cost the same, the method would not matter. It matters when prices move. When your supplier keeps putting prices up, and over the last few years most have, FIFO gives a higher closing stock and a higher profit than the alternatives. When prices fall, the effect reverses.
A Worked Example: One Roaster, Three Profit Figures
Calder Valley Coffee Ltd is a small speciality roaster with a 31 March year end. It buys green coffee beans by the kilo. Over the year to 31 March 2026, the price of its main bean rose steadily.
| Date | Kilos | Price per kg | Cost |
|---|---|---|---|
| Opening stock, 1 April 2025 | 500 | £6.00 | £3,000 |
| Purchase, May 2025 | 2,000 | £6.50 | £13,000 |
| Purchase, August 2025 | 2,000 | £7.20 | £14,400 |
| Purchase, November 2025 | 2,000 | £7.80 | £15,600 |
| Purchase, February 2026 | 1,500 | £8.40 | £12,600 |
| Total available | 8,000 | £58,600 |
The year-end count found 1,200 kilos still in the warehouse, so 6,800 kilos were roasted and sold. Sales for the year were £142,000. To keep the example clean we will ignore roasting costs, packaging and wastage.
FIFO
FIFO assumes the oldest beans went first, so the 1,200 kilos left over are the most recent ones, all from the February delivery.
Closing stock = 1,200 × £8.40 = £10,080
Cost of sales = £58,600 − £10,080 = £48,520
Weighted average cost
The average cost of every kilo available in the year was £58,600 ÷ 8,000 = £7.325.
Closing stock = 1,200 × £7.325 = £8,790
Cost of sales = £58,600 − £8,790 = £49,810
LIFO (for comparison only)
LIFO assumes the newest beans went first, so the 1,200 kilos left are the oldest: the 500 kilos of opening stock at £6.00 and 700 kilos from May at £6.50.
Closing stock = £3,000 + £4,550 = £7,550
Cost of sales = £58,600 − £7,550 = £51,050
Putting them side by side
| FIFO | Weighted average | LIFO (not allowed in UK) | |
|---|---|---|---|
| Sales | £142,000 | £142,000 | £142,000 |
| Cost of sales | £48,520 | £49,810 | £51,050 |
| Gross profit | £93,480 | £92,190 | £90,950 |
| Closing stock | £10,080 | £8,790 | £7,550 |
Same beans, same sales, same cash in the bank. Three different gross profit figures, £2,530 apart.
What That Difference Is Really Worth
Calder Valley's taxable profit sits in the marginal relief band for corporation tax, where the effective rate on each extra pound is 26.5%.
- FIFO instead of weighted average adds £1,290 of profit, which is about £342 of extra corporation tax this year.
- FIFO instead of LIFO would add £2,530 of profit, about £670 of tax.
Here is the part most guides leave out. That tax is not lost. Next year, the £10,080 of FIFO closing stock becomes opening stock and flows into cost of sales, so next year's profit is lower by the same amount. The method moves profit between years. It does not create or destroy it.
That is why, in our experience, the choice between FIFO and weighted average is rarely the thing that matters on a small company's accounts. For Calder Valley the gap is £342 of tax timing. A miscount of 150 kilos at the stocktake would move profit by more than £1,200. Getting the count right, and writing down stock that will not sell, matter far more than the method. We cover the write-down side in stock turnover.
Why LIFO Is Not Allowed in the UK
LIFO is prohibited by both sets of accounting standards used in the UK.
- FRS 102, the standard most UK private companies follow, says in Section 13 that the cost of interchangeable stock is measured using FIFO or weighted average cost, and that LIFO is not permitted.
- IAS 2, the international standard used by listed groups, removed LIFO as an option in its 2003 revision.
The reasoning is simple once you see the example above. LIFO leaves the balance sheet carrying stock at prices that can be years or even decades out of date. A business that had used LIFO since the 1990s could be showing its warehouse at a fraction of what it would cost to refill. That makes the balance sheet close to useless as a picture of what the business holds.
HMRC does not accept LIFO for tax either. Its Business Income Manual (BIM33120) points back to a 1956 Privy Council case, Minister of National Revenue v Anaconda American Brass Ltd, where LIFO was rejected as not reflecting the true profit. That position has not moved since.
The United States is the exception. US tax law allows LIFO, and plenty of US companies use it because, when prices rise, it gives a lower profit and a lower tax bill. That is why so many American bookkeeping sites walk through LIFO calculations in detail. If you are working from a US template, an American online course or a non-UK accounting package, check this first.
FIFO in the Warehouse vs FIFO in the Accounts
FIFO means two different things, and they get mixed up all the time.
In a warehouse, kitchen or shop, FIFO is a stock rotation rule. You put new deliveries at the back and sell the oldest first, so nothing goes out of date. Food businesses are expected to work this way for safety reasons.
In the accounts, FIFO is a cost assumption. It decides which prices are attached to the units you still hold. It does not have to match what physically happened.
You can rotate stock physically on a FIFO basis and value it at weighted average cost. That is perfectly acceptable, and it is what many small retailers actually do because their software uses average cost. The accounting method is about measuring cost fairly, not describing where the boxes went.
Specific Identification and the Other Allowed Methods
FIFO and weighted average are for stock where one unit is the same as the next, like coffee beans, screws or T-shirts in a size. Some stock is not like that.
Specific identification. Where items are not ordinarily interchangeable, FRS 102 expects you to track the actual cost of each one. A used car dealer, a jeweller, an art dealer or a builder with individual plots should be valuing each item at what that item cost, not an average.
Standard cost, retail method and most recent purchase price. FRS 102 also lets you use shortcuts if the result is close to actual cost. A manufacturer might value stock at a standard cost per unit, reviewed regularly. A shop with thousands of lines might work back from selling price using its normal margin. A small business whose stock turns over every few weeks can often use the latest invoice price, because that is close to FIFO anyway.
The rule that holds all of these together is consistency. You should use the same method for stock of a similar nature and use, and keep using it from year to year.
What Goes Into the Cost of Stock
The method decides which prices you use. You also need to get the price itself right. Under FRS 102 the cost of stock includes:
- The purchase price, less any trade discounts and rebates.
- Import duties and non-recoverable taxes. If you are VAT registered and can reclaim the VAT, leave it out. If you cannot reclaim it, it is part of the cost.
- Delivery and handling costs to get the stock to where it is sold or used. Freight in is a cost of stock. Delivery out to customers is not.
- Conversion costs for anything you make or process, including a share of production overheads based on normal output.
For Calder Valley, that last point matters. Roasted coffee in bags should carry the cost of the green beans, the roasting labour, the gas and a share of the roaster's depreciation, not just the price of the beans. Leaving conversion costs out understates closing stock and understates profit, which tends to get corrected at the year end with an awkward jump in the figures.
Stock is then carried at the lower of cost and estimated selling price less costs to complete and sell. If Calder Valley had a batch of beans that had gone stale and could only be sold cheaply as a blend filler, it would be written down to that lower figure whatever method is used.
Can You Change Your Stock Valuation Method?
Yes, but not to manage profit from one year to the next.
Under FRS 102 Section 10, you can change an accounting policy only if a standard requires it or the new policy gives more reliable and relevant information. Moving from FIFO to weighted average because this year's profit looks high is not a good enough reason, and an auditor or HMRC would be right to ask about it.
A genuine change, for example because you have moved to new inventory software that only supports average cost, is treated as a change in accounting policy. The comparative figures are restated, and any difference in opening stock is adjusted. For tax, HMRC has specific rules on a change of accounting basis (see BIM34000) that bring the adjustment into charge, so the change does not let profit slip through untaxed. Talk to your accountant before switching, not after.
What Your Software Is Probably Doing
Many small businesses are using a stock valuation method without knowing it, because the software made the choice.
At the time of writing, Xero's tracked inventory values items at average cost, and QuickBooks Online uses FIFO. Dedicated stock and ecommerce systems vary, and some let you choose. None of them use LIFO by default for UK accounts.
That is usually fine. The problems come when the software figure and the year-end figure do not match, typically because:
- purchases were coded straight to an expense account instead of the tracked item, so the system thinks stock is lower than it is;
- freight and import duty were posted to overheads instead of the stock cost;
- the stock count was never entered, so the system figure has drifted from what is actually on the shelves.
If you use Xero, it is worth checking once a quarter that the inventory report agrees to the stock figure on the balance sheet. When they differ, the balance sheet is usually the one that is wrong.
Which Method Should a Small UK Business Use?
Our view, for most owner-managed businesses:
- Use whatever your software uses, as long as it is FIFO or weighted average. The difference between the two is usually small and reverses the following year. A method you can actually run every month beats a theoretically better one you only work out at the year end.
- Use specific identification for high-value, one-off items. Vehicles, machinery held for resale, property, jewellery and artwork should be valued item by item.
- Avoid anything that looks like LIFO, including spreadsheet templates that value year-end stock at "the first price we paid this year".
- Pick a method and stick with it. Consistency matters more to HMRC, lenders and buyers than which of the two allowed methods you chose.
If you are a sole trader using the cash basis, there is no closing stock adjustment for tax, so the method does not affect your tax bill. It is still worth keeping a stock figure for your own management purposes.
Common Mistakes We See
- Using LIFO because an online tutorial did. It is not allowed in UK accounts or for UK tax.
- Valuing stock at selling price. Stock goes in at cost, unless it is worth less than cost.
- Including recoverable VAT in the stock figure. If you reclaim the VAT, stock is valued net of it.
- Leaving out freight, duty and production costs that should be part of the cost of stock.
- Changing method to flatter a bad year. It only moves profit into the next year, and it raises questions.
- Trusting the system figure without a count. A valuation method applied to the wrong quantity is still wrong.
How IAK Can Help
We work with small businesses, limited companies and sole traders across North London and Hertfordshire, including retailers, food businesses, wholesalers and makers that carry real stock. Stock valuation usually comes up at the year end, when the stocktake figure does not match the software or the gross margin has moved for no obvious reason.
We can set up your stock tracking properly in bookkeeping, check the method and the cost build-up as part of your year-end accounting, and track stock, margin and working capital monthly through management reporting. If you would rather talk it through, get in touch.
Sources
- FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland, Financial Reporting Council, Section 13 Inventories, on FIFO and weighted average cost, the prohibition of LIFO, specific identification and the cost of inventories. Section 10 covers changes in accounting policy.
- IAS 2 Inventories, IFRS Foundation, on cost formulas under international standards.
- BIM33120: Stock and work in progress, FIFO and LIFO, HMRC Business Income Manual, on HMRC not accepting LIFO for tax.
- BIM34000: Change of accounting basis, HMRC Business Income Manual, on the tax treatment of a change in accounting policy.
- Corporation Tax rates and reliefs, GOV.UK, for the 25% main rate, the 19% small profits rate and marginal relief between £50,000 and £250,000.