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:
- 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
- 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.
[table id=5 /]
Calculate the Cost of Sales and Ending inventory value using FIFO method under:
(a) Periodic system
(b) Perpetual system
(a) LIFO Inventory valuation under Periodic system
Calculation of Units available for Sale:
[table id=6 /]
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
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:
[table id=11 /]
Calculate of Cost of Goods sold:
Now that we know goods available for sale and ending inventory we can calculate cost of goods sold.
[table id=12 /]
(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.
[table id=13 /]