Last In, First Out
Last in, first out (LIFO) is a method used to account for business inventory that records the most recently produced items in a series as the ones that are sold first. That is, the cost of the most recent products purchased or produced is the first to be expensed as cost of goods sold (COGS), while the cost of older products, which is often lower, will be reported as inventory.Two alternative methods of inventory costing include first in, first out (FIFO), in which the oldest inventory items are recorded as sold first, and the average cost method, which takes the weighted average of all units available for sale during the accounting period and uses that average cost to determine COGS and ending inventory.
Last In, First Out (LIFO)
Definition: Last In, First Out (LIFO) is an inventory valuation method where the most recently produced or purchased goods are recorded as the first to be sold. This means that the cost of the most recently acquired or produced products is recorded as the cost of goods sold, while the cost of earlier purchased products, usually lower, is reported as inventory.
Origin: The LIFO method was introduced in the early 20th century, primarily to address cost accounting issues during periods of inflation. By recording the latest costs as the cost of goods sold, companies can reduce taxable income during inflationary periods.
Categories and Characteristics:1. First In, First Out (FIFO): Contrary to LIFO, the FIFO method records the earliest inventory items as the first to be sold.2. Weighted Average Cost: This method determines the cost of goods sold and ending inventory using the weighted average cost of units available for sale during the accounting period.
Characteristics: LIFO can reduce a company's taxable income during inflationary periods but may increase tax liability during deflationary periods. Additionally, LIFO is not permitted under International Financial Reporting Standards (IFRS).
Case Studies:1. Case 1: A company purchases two batches of inventory at $10 and $12 respectively within a month. Using the LIFO method, if the company sells one item, the cost of goods sold will be recorded as $12, while the remaining inventory cost will be $10.2. Case 2: During an inflationary period, a company using the LIFO method records higher costs of goods sold, thereby reducing taxable income and saving on taxes.
Common Questions:1. Why is LIFO not allowed under IFRS? Because LIFO can result in financial statements that do not accurately reflect a company's actual financial condition.2. When is it more advantageous to use LIFO? During inflationary periods, using LIFO can reduce taxable income and save on taxes.
