LIFO

Last-in, first-out (LIFO) is an inventory method popular with companies that experience frequent increases in the cost of their product. LIFO is used primarily by oil companies and supermarkets, because inventory costs are almost always rising, but any business can use LIFO. Remember, there is no correlation between physical inventory movement and cost method.

To visualize how LIFO works, think of one of those huge salt piles that cities and towns keep to salt icy roads. The town gets a salt delivery and puts it on top of the pile. When the trucks need to be filled, does the town take the salt from the top or bottom of the pile? The trucks are filled from the top of the pile. The last delivery in is the first to be used. This is the essence of LIFO. When calculating costs, we use the cost of the newest (last-in) products first.

When costs are rising, LIFO will give the highest cost of goods sold and the lowest gross profit. LIFO will also result in lower taxes than the other inventory methods.

LIFO Using a Periodic Inventory System

LIFO1

For all periodic methods we can separate the purchases from the sales in order to make the calculations easier. Under the periodic method, we only calculate inventory at the end of the period. Therefore, we can add up all the units sold and then look at what we have on hand.

LIFO2

We sold 245 units during the month of January. Using LIFO, we must look at the last units purchased and work our way up from the bottom. Start with the 50 units from January 26th and work up the list. We would then take the 90 units from January 22nd, and 50 units from January 12th. That gives us 190 units. We are still 55 short, so we will take 55 from January 3rd.

LIFO3

The cost of goods sold for the 245 units, using LIFO, is $2,032.00. Now we need to look at the value of what is left in ending inventory. We have 20 units left from the January 3rd purchase and all the units from beginning inventory.

LIFO4

Gross profit (sales less cost of goods sold) under LIFO is $2,868.00. Under LIFO, our cost of goods sold is higher than it was under FIFO and our ending inventory is lower than under FIFO. Gross profit is lower under LIFO than FIFO, which would result in lower income taxes because overall profit would be lower.

Adding cost of goods sold and ending inventory gives us $3,394.00 which ties back to goods available for sale. Everything has been accounted for in our calculation.

LIFO Perpetual

Under a perpetual inventory system, inventory must be calculated each time a sale is completed. The method of looking at the last units purchased is still the same, but under the perpetual system, we can only consider the units that are on hand on the date of the sale.

LIFO1

Imagine you were actually working for this company and you had to record the journal entry for the sale on January 7th. We would do the entry on that date, which means we only have the information from January 7th and earlier. We do not know what happens for the rest of the month because it has not happened yet. Ignore all the other information and just focus on the information we have from January 1st to January 7th.

LIFO5

LIFO means last-in, first-out. Based on the information we have as of January 7th, the last units purchased were those on January 3rd. We will take the cost of those units first, but we still need another 25 units to have 100. Those units will come from beginning inventory.

LIFO6

The cost of the January 7th sale is $807.50. Now, we can move on to the next sale, updating our inventory figures. There are no units remaining from the January 3rd purchase and 125 left in beginning inventory. Before the January 17th sale, we purchased 50 units on January 12th.

LIFO7

We need 65 units for this sale. Since we are using LIFO, we must take the last units in, which would be the units from January 12th. Then we would take the remaining 15 units needed from beginning inventory.

LIFO8

One more sale remaining. Again, we will update the remaining units before considering the sale.

LIFO9

The company sold 80 units on January 31st. Which units should we use for cost using LIFO? The last units in were from January 26th, so we use those first, but we still need an additional 30. We take those from January 22nd.

LIFO10

To calculate total cost of goods sold, add the cost of each of the sales.

LIFO11

You could also add $807.50 plus $532.50 plus $673.00 which also equals $2,013.00.

You may have noticed that perpetual inventory gave you a slightly lower cost of goods sold that periodic did. Under periodic, you wait until the end of the period and then take the most recent purchases, but under perpetual, we take the most recent purchases at the time of the sale. Under periodic, none of the beginning inventory units were used for cost purposes, but under perpetual, we did use some of them. Those less expensive units in beginning inventory led to a lower cost of goods sold under the perpetual method. You will also notice that ending inventory is slightly higher. Look at the differences in the units that are left in ending inventory.

LIFO12

Under perpetual we had some units left over from January 22nd, which we did not have under periodic.

When using a perpetual inventory system, dates matter! Make sure to only consider the units on hand at the time of the sale and work backwards accordingly.

Related Video

LIFO Calculations

Share This:


Related pages


allocating manufacturing overhead costs is donetotal variable costs formulawhat type of account is sales returns and allowanceshow to prepare closing entries in accountingaging account receivablejournal entries for periodic inventory systemimportance of contribution marginwhat happens to retained earnings when a business closesprepaid expense in balance sheethow to remember debits and credits in accountingdepreciation expense journal entryassets liabilities equity equationjob order costing managerial accountingdefine bank reconciliation statementpresent value of an ordinary annuity of 1computing cost of goods manufacturedcost accounting overhead calculationhow to compute annual interest ratejanitor wagesreturn of capital journal entrypresent value of a annuitybreak even managerial accountingmanufacturing p&lnetpay payrollthe formula for total fixed cost ishow to calculate contributed capitalaveraging down calculatorprepare a statement of retained earningshow to calculate labor hours per unitunearned revenue balance sheettwo methods of accounting for uncollectible accounts are thecash basis accounting journal entriespv discount factorformula for asset turnoverprepayment journal entryincome statement for managerial accountingintroduction to financial accounting textbookincome statement unearned revenuesample trial balance worksheetoverhead cost ratenormal balance of unearned revenuecalculate double declining depreciationreceivable ageingtn payroll tax calculatorequation for ending inventoryss wage base 2014formula for ending inventoryincome statement cost of goods manufacturedreceived cash on account journal entrydeclining balance method calculatorpercentage of sales method calculatorjournal entry for accrualhow to pay unemployment taxessegmented income statement exampleaccumulated depreciation general ledgercost of good sold statement formatformula for retained earningsreconciliations in accountingcalculate federal witholdingwhat is lifo methodmonthly closing entries accountingwhat is fwt taxboeing dell discountsocial security and medicare withholding ratesexample payroll journal entrydefine inventories in accountingcalculate gross salaryoverhead allocation rate formula1000000 annuitycogs formula income statement