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The Last-in, First-out Method | LIFO Inventory Method

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The last in, first out (LIFO) method is used to place an accounting value on inventory. The

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the first one sold. Picture a store shelf where a clerk adds items from the front, and

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customers also take their selections from the front; the remaining items of inventory that

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are located further from the front of the shelf are rarely picked, and so remain on the shelf

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that is a LIFO scenario.

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LIFO method operates under the assumption that the last item of inventory purchased is

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What is LIFO?

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The trouble with the LIFO scenario is that it is rarely encountered in practice. If a company
were to use the process flow embodied by LIFO,
a significant part of its inventory would be
very old, and likely obsolete. Nonetheless, a company does not actually have to experience

the LIFO process flow in order to use the method to calculate its inventory valuation.
Effects of LIFO Inventory Accounting
The reason why companies use LIFO is the assumption that the cost of inventory increases
over time, which is a reasonable assumption in times
of inflating prices. If you were to use
LIFO in such a situation, the cost of the most recently acquired inventory will always be
higher than the cost of earlier purchases, so your ending inventory balance will be valued at
earlier costs, while the most recent costs appear in the cost of goods sold. By shifting highcost inventory into the cost of goods sold, a company can reduce its reported level of
profitability, and thereby defer its recognition of income taxes. Since income tax deferral
is
the only justification for LIFO in most situations, it is banned under international financial
reporting standards (though it is still allowed in the United States under the approval of the
Internal Revenue Service).
Example of the Last-in, First-out Method
Milagro Corporation decides to use the LIFO method for the month of March. The following
table shows the various purchasing transactions for
the companys Elite Roasters product.
The quantity purchased on March 1 actually reflects the inventory beginning balance.
Quantity

Cost per

Units

Cost of

Cost of

Total

Purchased

Unit

Sold

Layer #1

Layer #2

Cost

March 1

150

$210

95

(55 x $210)

March 7

100

235

110

(45 x $210)

March 11

200

250

180

(45 x $210)

(20 x $250)

14,450

March 17

125

240

125

(45 x $210)

(20 x $250)

14,450

March 25

80

260

120

(25 x $210)

Date
Purchased

$11,550
9,450

5,250

The following bullet points describe the transactions noted in the preceding table:
March 1. Milagro has a beginning inventory balance of 150 units, and
sells 95 of these
units between March 1 and March 7. This leaves one inventory layer of 55 units at a

http://www.accountingtools.com/lifo-method[3/29/2015 11:41:17 AM]

LIFO Method - AccountingTools

cost of $210 each.
March 7. Milagro buys 100 additional units on March 7, and sells 110
units between
March 7 and March 11. Under LIFO, we assume that the latest purchase was sold first,
so there is still just one inventory layer, which has now been reduced to 45 units.
March 11. Milagro buys 200 additional units on March 11, and sells 180 units between
March 11 and March 17, which creates a new inventory layer that is comprised of 20
units at a cost of $250. This new layer appears in the table in the Cost of Layer #2
column.
March 17. Milagro buys 125 additional units on March 17, and sells 125 units between
March 17 and March 25, so there is no change in the inventory layers.
March 25. Milagro buys 80 additional units on March 25, and sells 120 units between
March 25 and the end of the month. Sales exceed purchases during this period, so the
second inventory layer is eliminated, as well as part of the first layer. The result is an
ending inventory balance of $5,250, which is derived from 25 units of ending inventory,
multiplied by the $210 cost in the first layer that existed at the beginning of the month.
Related Topics
FIFO vs. LIFO accounting
First-in first-out method
Specific identification method
Weighted average method
What are perpetual LIFO and periodic LIFO?

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