Last In First Out (LIFO) Method

Last In First Out (LIFO) method is one of the three cost assignment methods used to value period end inventory still at hand and cost of goods sold during the period.

LIFO assumes that the newest inventory purchased/produced is used or consumed first and the oldest inventory (that may include units of inventory held at the beginning of the period) remains in the warehouse by the end of the period.



The implication of Last In First Out assumption is that cost of goods sold will based on cost of most recent inventory purchased or produced and the value of period end inventory is based on cost of oldest inventory held by the entity. This means that cost of goods sold will be much closer reflection of prices prevailing in the market by end of the period. Closing inventory on the other hand will reflect the cost prevailing at the beginning of the period.

Use of LIFO method under different economies must be an important consideration as it can have significant impact on figures involving ending inventory:

  1. In case of rising prices, the cost allocated to units sold during the period will be higher than the cost allocated to units still with the entity by the end of the period
  2. In case prices are falling, the cost attributed to units sold during the period will be lesser than the cost attributed to inventory still at hand by the end of the period.

1 LIFO under different inventory systems

Depending upon the nature of inventory and the business, entities may choose either periodic inventory system or perpetual inventory system to manage the records of inventory. Unlike FIFO that gives the same results under both the inventory systems, the choice of inventory system will affect the cost of sales and ending inventory value if LIFO method is used. Just like AVCO, LIFO will not render same results under periodic and perpetual inventory systems.

Lets understand this with the help of following example.

Example: LIFO under Periodic and Perpetual inventory systems

For the month ended details of inventory related transaction is provided.

1-Jul
3-Jul
7-Jul
15-Jul
18-Jul
22-Jul
25-Jul
28-Jul
31-Jul
Starting inventory
Purchases
Purchases
Sales
Purchases
Sales
Sales
Purchases
Sales
76 units @ $10/unit
150 units @ $12/unit
50 units @ $11/unit
100 units
80 units @ $15/unit
120 units
10 units
200 units @ $14/unit
67 units

Calculate the Cost of Sales and Ending inventory value using FIFO method under:

(a) Periodic system
(b) Perpetual system

Solution:

(a) LIFO Inventory valuation under Periodic system

Calculation of Units available for Sale:

DateTransactionUnitsRateTotal
1-Jul
3-Jul
7-Jul
18-Jul
28-Jul
Opening inventory
Purchases
Purchases
Purchases
Purchases
76
150
50
80
200
10
12
11
15
14
760
1800
550
1200
2800
5567110

Physical count of inventory:

As we cannot count the inventory here so we are assuming it be same as we expect after all the transactions of purchases and sales and we can calculate the units:

= Units available for sale – Sales = Ending inventory
= 556 – (100+120+10+67)
= 556 – 297
= 259

Under FIFO method, our ending inventory will be from the latest purchases i.e. purchases of July 28 and 18 and thus valued as follows:

76 units
150 units
33 units
@ $10/unit (rate of July 1)
@ $12/unit (rate of July 3)
@ $11/unit (rate of July 7)
=
=
=
760
1800
363
259 units2923

Calculate of Cost of Goods sold:

Now that we know goods available for sale and ending inventory we can calculate cost of goods sold.

UnitsCost
Available for Sale
Less: Ending Inventory
556
(259)
7110
(2923)
Goods sold2974187

(b) LIFO Inventory valuation under Perpetual system

Under perpetual system all changes inventory are recorded as they happen, therefore we have a chronological record of all the transactions and at the end of the period we automatically get the cost of goods sold and value of ending inventory.

DatePurchasesSalesBalance
JulyQty.RateTotalQty.RateTotalQty.RateTotal
17610760
315012180076
150
10
12
760
1800
7501155076
150
50
10
12
11
760
1800
550
1550
50
11
12
550
600
76
100
10
12
760
1200
188015120076
100
80
10
12
15
760
1200
1200
2280
40
15
12
1200
480
76
60
10
12
760
720
25101212076
50
10
12
760
600
2820014280076
50
200
10
12
14
760
600
2800
31671493876
50
133
10
12
14
760
600
1862
2973888