What is the LIFO method?
The LIFO method (Last In First Out) is a way of determining which items of inventory have been sold during a period and which items remain in inventory at the end of the period. This will allow a business to determine the cost of goods sold and the value of the ending inventory. A method is needed because all items are not purchased at the same price.
Using the LIFO method the two units sold are the last in, which in this example are part of the purchases for the period.
LIFO Method Example
By way of illustration.
If a business had the following inventory information for October:
October 1 Beginning inventory 100 units @ 5.00 cost per unit
October 4 Purchased 400 units @ 5.50 cost per unit
October 10 Sold 200 units
Under the LIFO method the following happens:
- 100 units are added at 5.00 as beginning inventory
- 400 units are added at 5.50 as purchases
- 200 units are sold at with a cost of 5.50 (first units sold are those most recently put into inventory)
The cost of the goods sold would be given by 200 x 5.50 = 1,100. After the items have been sold 300 units (100 + 400 – 200) remain in ending inventory with a cost of 200 x 5.50 + 100 x 5.00 = 1,600
The LIFO method used in this example is demonstrated in the tables below.
LIFO Method Showing Units
The first table shows the movement in units. The items sold comprise 200 of the 5.50 units. It also shows that the remaining ending inventory is 200 of the 5.50 units and 100 of the 5.00 units.
|@ 5.00||@ 5.50||Units|
LIFO Method Showing Value
This table converts the units in the table above to values at either 5.00 or 5.50 per unit.
|@ 5.00||@ 5.50||Value|
The LIFO method is one of the available methods used in inventory management. Clearly the method used to determine which units are sold and which remain in ending inventory determines the value of the cost of goods sold and the ending inventory. As profit depends on the cost of goods sold, the method chosen will affect the profits of a business.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.