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Overview of Last-In, First-Out (LIFO)
Definition of
Last-In, First-Out (LIFO)
What is Last-In, First-Out (LIFO)? Last-In, First-Out (LIFO) is an inventory valuation method used in accounting where it is assumed that the most recently acquired (last-in) units of inventory are the first ones to be sold. Under LIFO, the Cost of Goods Sold (COGS) is based on the cost of the newest inventory, while the ending inventory on the Balance Sheet is valued at the cost of the oldest items. This method is primarily used in the United States and is not permitted under International Financial Reporting Standards (IFRS).
Activities Related to
Last-In, First-Out (LIFO)
Here is a list of LIFO related activities:Â
Tracking the cost and purchase date of each inventory unit, Applying the "last-in, first-out" cost flow assumption when goods are sold, Calculating Cost of Goods Sold based on the cost of the newest inventory items, Valuing ending inventory based on the cost of the oldest purchases, Managing LIFO layers and potential LIFO liquidation issues, Complying with GAAP regulations for LIFO if used in the U.S., and Calculating potential tax deferrals during inflationary periods.
These activities are specific to businesses opting for the LIFO valuation method where permitted.
The Importance of
Last-In, First-Out (LIFO)
The LIFO method is important, particularly in the U.S., because during periods of rising prices (inflation), it generally results in a higher Cost of Goods Sold and, consequently, a lower reported net income and lower taxable income. This potential for tax deferral is a primary reason some companies choose LIFO. However, it also means that the ending inventory value on the Balance Sheet may be significantly understated compared to current replacement costs, potentially distorting financial ratios. Understanding the impact of LIFO is crucial for accurate financial statement analysis and comparing companies that use different inventory methods.
Key Aspects of
Last-In, First-Out (LIFO)
Cost Flow Assumption
Assumes the newest inventory items are sold first. This rarely matches the actual physical flow of goods.
Impact on COGS & Profit
In inflationary periods, LIFO results in a higher COGS and lower net income compared to FIFO.
Ending Inventory Valuation
Ending inventory is valued at the cost of the oldest purchases, which may not reflect current market values.
IFRS Prohibition
LIFO is not permitted under International Financial Reporting Standards (IFRS), limiting its use globally. It is allowed under U.S. GAAP.
Concepts Related to
Last-In, First-Out (LIFO)
Last-In, First-Out (LIFO) is one of the main Inventory Valuation Methods, contrasted with First-In, First-Out (FIFO) and the Weighted-Average Method. Its application affects the Cost of Goods Sold (COGS) on the Income Statement and the Inventory value on the Balance Sheet. Concepts like "LIFO reserve" and "LIFO liquidation" are specific to this method. It is guided by GAAP in the U.S. but not by IFRS.
LIFO Inventory
in Action:
The Adventures of Coco and Cami
Cami stacks her newest coffee bean bags on top of the old ones. Professor A uses this to explain LIFO – where it's assumed the last items bought are the first ones used or sold.
Discover with Coco and Cami how LIFO can affect their reported costs and profits, especially when prices for their supplies change, and why it's not used everywhere.