What is the Last-In-First-Out (LIFO) Accounting Method?

LIFO (Last-in First Out) is an asset-management and inventory accounting method. Per this system, the assets (inventory) received or manufactured last are the first to be sold. Older inventory is sold only after the newest inventory is sold. Remember, this is a designation for accounting. The actual inventory being sold is the same. The purpose of this system is to simply account for the cost (expensing) of this new inventory immediately.

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How does the Last In First Out Accounting Method (LIFO) Work?

Accounting practices let users estimate cost flow. The company incurs a cost as items are made; however, the company records the expense (cost of goods sold) when the inventory is sold. The production costs include labor costs and material/inventory purchases. LIFO assumes that inventory sold was the last items of inventory to be purchased or produced. For instance, if you bought 100 items for $10 and later purchased an additional 100 items for $15. As per LIFO, the cost of the first item resold will be $15. Once you sell 100 items, additional item will have cost $10. In inflationary markets and increasing pricing, LIFO is beneficial, as it allocates the older and higher costs to COGS (cost of goods sold) expense. This higher expense allocation means lower profits on sales and thus a lower amount of taxation. As an alternative to LIFO and FIFO, the average cost of inventory approach allocates the same cost to each item. This method calculates the average cost by diving inventory cost by total items available for sale.