Last in, first out (LIFO) – what is it?

Apr 16, 2022

Level: Beginner

Reading time: 5 min

Every business has to measure its inventory in line with commonly used accounting measurement methods. One such is the last in, first out (LIFO). It is an inventory management system to track the flow of goods within an organization. Under it, the latest items added to inventory are the first ones sold.

So if you are a PVE gamer who wants to know how to get the First In, Last Out, and what the god rolls are, you need a completely different article. Here we will explore the LIFO as an inventory method.

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What is last in, first out (LIFO)?

Last in, first out inventory methodology tracks stock levels and the cost of goods sold in businesses. The LIFO is primarily used in the United States and governed by its generally accepted accounting principles (GAAP). With this method, the last items purchased or received are recorded first, and the costs associated with them are used to calculate the cost of goods sold.

This inventory measurement method is often used in businesses that sell perishable goods, like fish, fruits, etc. It is also commonly used for accounting for assets with short life spans, such as computers, office supplies, and other technology. The last-in-first-out method assists in ensuring that the newest items are always available for sale and the customer gets the latest product.

How does the last in, first out method work?

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The last in, first out method works by recording those inventory purchases or deliveries first in the company’s books that came into the warehouse recently. In other words, the most recent items or products are recorded on the books first.

Calculating the cost of goods also uses the recent items instead of the oldest deliveries. This helps businesses view their stock levels better since they’re selling the newest items first.

The main advantage of using the last in, first out method is that it helps firms better match their sales to the costs of goods sold. This is because when businesses use LIFO, they can determine exactly which items are costing them more and selling for a lower price, thus helping them adjust their pricing strategies accordingly.

The LIFO method also prevents companies from over-investing in inventory since they know the last items purchased are the latest items sold.

Understanding last in, first out

Understanding LIFO is essential for businesses that want to remain competitive and profitable, especially for those that sell perishable items like food and medicines and durable goods such as electronics. The LIFO method empowers firms to keep track of their stock items more efficiently by ensuring that the last thing gets used first.

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This inventory control system is also advantageous to businesses needing to access their products quickly. It reduces the chance of having outdated or expired items on hand and ensures that the customer gets the best product available in the store.

LIFO, inflation, and net income

When there is zero inflation, all inventory management methods will render the same results. However, choosing it during high inflation can have a great impact on the valuation ratios. First in, first out (FIFO), LIFO, and weighted average cost method, all have different effects:

FIFO increases the net income because the stock used to value the cost of goods sold might be several years old, which can directly impact an increase in taxes. However, it reflects a better indication of the closing inventory on the balance sheet.
LIFO, contrary to FIFO, shows a lower net income, resulting in lesser taxes. However, it is not the best indicator of closing inventory because its value might be understated.
The weighted average cost method delivers results that lie somewhere between FIFO and LIFO.

Note! Last in, first out (LIFO) is the same as first in, last out (FILO). It is a way of processing data structures in which the last element is processed first and the first one processed last. It stands for the FIFO approach in programming.

Example of last in, first out

Assume a company has ten boxes of widgets in inventory. The last five boxes, $200 each, were added last month, while the other five were $100 each and were added two months ago.

Suppose seven widgets are sold. How much can the accountant record as their cost? According to last in, first out (LIFO) accounting rules, the last inventory is the first one sold, i.e., the widgets priced at $200 were sold first. Following them, the firm sold two more boxes for $100. That is, the cost of the sold is 5*$200+2*$100=$1,200.

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If the company used FIFO, $100 products would count as sold first and $200 widgets second. As a result, the cost of what was sold would be recorded as 5*$100+2*$200=$900.

Why use the LIFO inventory method?

The last-in-first-out inventory method helps companies achieve better financial results on their income statements. By recording last-in items as the first ones sold, a firm can reduce the cost and, therefore, the number of profits it reports.

The method is also used for tax reasons in some countries. For example, in the United States, last-in items are assumed to be sold first, leading to lower taxable income if there is a higher cost associated with last-in items.

The bottom line

In a nutshell, the last-in, first-out inventory method is a standard accounting principle that assumes items received last are the first ones sold. It can benefit companies as it helps them achieve better financial results on their income statements and helps them reduce their taxes.

Understanding how LIFO works and the implications it has on inventory valuation is paramount. By using it, businesses can ensure they get the most out of their inventory and keep adequate accounting records.

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