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

The key difference between FIFO (First In, First Out) and LIFO (Last In, First Out) in inventory accounting lies in the order of how inventory costs are recognized when items are sold. FIFO assumes that the oldest inventory items are sold first. This means that the cost of goods sold (COGS) reflects the cost of the oldest inventory available, while the remaining inventory reflects the cost of the more recent purchases. This method typically results in a lower COGS during periods of rising prices, which can lead to higher net income and higher taxes.

On the other hand, LIFO operates on the principle that the newest inventory is sold first. Under this method, the costs assigned to the goods sold are based on the more recent inventory purchases, which often leads to a higher COGS during inflationary periods. As a result, LIFO can reduce taxable income and tax obligations, but it can also show a lower net income on financial statements when compared to FIFO.

This distinction is fundamental for businesses as it can affect financial analysis, inventory valuation, profit reporting, and tax liabilities. The other choices incorrectly depict the relationship between FIFO and LIFO or fail to accurately reflect their usage and implications in accounting practices.