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 stock at the end of the period. This will allow a business to determine the cost of goods sold and the value of the closing inventory. A method is needed because all items are not purchased at the same price.
The LIFO method assumes that the goods most recently put into inventory are used first. The inventory purchased last (in) is sold first (out).
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 opening stock
- 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 closing 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 closing inventory is 200 of the 5.50 units and 100 of the 5.00 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.
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 closing inventory determines the value of the cost of goods sold and the closing inventory. As profit depends on the cost of goods sold, the method chosen will affect the profits of a business.