What is Last In, First Out ?
924 reads · Last updated: December 5, 2024
Last in, first out (LIFO) is a method used to account for business inventory that records the most recently produced items in a series as the ones that are sold first. That is, the cost of the most recent products purchased or produced is the first to be expensed as cost of goods sold (COGS), while the cost of older products, which is often lower, will be reported as inventory.Two alternative methods of inventory costing include first in, first out (FIFO), in which the oldest inventory items are recorded as sold first, and the average cost method, which takes the weighted average of all units available for sale during the accounting period and uses that average cost to determine COGS and ending inventory.
Definition
Last In, First Out (LIFO) is a method used for inventory accounting where the most recently produced or purchased goods are recorded as sold first. This means the cost of the most recently acquired or produced products is recorded as the cost of goods sold, while the cost of earlier purchased products, usually lower, is reported as inventory.
Origin
The LIFO method originated in the early 20th century, evolving with the increasing industrialization and the need for better inventory management. It became widely adopted in the United States during the 1930s, especially during periods of inflation, as it helped companies reduce taxable income.
Categories and Features
LIFO is primarily used during inflationary periods because it allocates higher recent costs to the cost of goods sold, thereby reducing taxable income. Its main features include: 1. Reducing taxable income during price increases; 2. Potentially undervaluing inventory; 3. Not allowed under International Financial Reporting Standards (IFRS).
Case Studies
Case Study 1: In the 1970s, U.S. oil companies like ExxonMobil used LIFO to cope with rising oil prices by allocating high-cost recent inventory to the cost of goods sold, thus reducing taxable income. Case Study 2: During the 2008 financial crisis, many retail companies like Walmart adopted LIFO to manage inventory costs, helping maintain financial stability amid economic uncertainty.
Common Issues
Common issues include: 1. LIFO is not widely accepted internationally, especially under IFRS; 2. It may lead to undervaluation of inventory, affecting the accuracy of financial statements; 3. During price declines, it may result in higher taxable income.
