Last in First Out (LIFO)

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​  LIFO is a method used for cost flow assumption purposes in the cost of goods sold calculation.  ​The LIFO method of inventory valuation assumes the most recent products or, "last in" products of a company’s inventory have been used first.

  The costs paid for the most recent products purchased are the ones used in the cost of goods sold calculation.  In other words, LIFO is the opposite of FIFO.  Much like FIFO there is not necessarily a relationship with the actual physical movement of inventory and the accounting assumption.  So, why would a company want to use LIFO?  Remember, always speak with your accountant or CPA before deciding on a valuation method.  They will give you the best advice for your specific needs.
Benefits of LIFO:

• The biggest benefit of LIFO is the tax advantage. Sometimes the cost to produce or purchase goods increases.  When these periods of inflation occur LIFO may be a good option.  During times of inflation, LIFO results in a higher cost of goods sold and a lower balance of remaining inventory. A higher cost of goods sold means lower net income, which results in a smaller tax liability.  With that being said, if the inflationary period is going to be a long one it may be beneficial to reduce profits and pay less in taxes.

Remember, we are not recommending what valuation method you should use.  This should be done by a licensed accountant, CPA or Accounting attorney if they are qualified.
Example of LIFO:

• Let’s say we purchase 100 items for $5 each and 100 more items are purchased next for $10 each.  We now have 200 items with a total value of $1500 in inventory.  Now let’s say we sell 20 items for $20 each.  LIFO would assign the cost of the last 20 items resold at $10 each.  Because we are using LIFO the cost of the first 20 items is $10 each and this means our Cost of Goods Sold is $200.00 and we Have a Remaining Value of $1300 in Inventory.  After 100 items total were sold, the new cost of the item would become $5, only if no new inventory was purchased.

One important thing to note about LIFO is that it is only permitted in the United States, under rules that are set by GAAP or Generally Accepted Accounting Principles.
Challenge:

• If we purchase 20 items at $15.00 each in month one, then in month two, we purchase 20 more items at $20.00 each and finally in month three we purchase 20 more items at $25 each and we sell 15 items. What would the cost be under the LIFO method and why?  Share your thoughts in the community, comments or upcoming assignments and receive a coupon for one of Lean Strategies International LLC's Training Courses.

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