What is LIFO?

Some accountants in the US often advise using the LIFO method for your inventory accounting when you have stock with frequently changing costs. Using LIFO as a preferred method for such scenarios helps match the latest cost of inventory with the sales revenue of the current period. This can be a more straightforward approach for initial inventory valuation as well as for tax filing purposes.

Unlike FIFO, LIFO has some disadvantages:

  • LIFO brings taxable income down when your cost price rises, but your profit will turn out significantly lower.
  • If, in the near future, you plan to expand your business, not all countries allow a LIFO valuation.
  • LIFO is not realistic for companies that sell perishable goods. Leaving the oldest inventory sitting idle could risk spoilage, leading to losses.

Example of LIFO

The same example used earlier can be used to show the LIFO method for calculating the cost of goods sold (COGS).

Buys an Item $100
Buys the same item after inflation $150
Sells an item for $175 -$150
Reported profit $25

In the LIFO method, when calculating profit, the most recent purchasing cost is subtracted from its selling price to calculate the reported profit. As you can see, using the LIFO method for inventory valuation and accounting lowers your return profit.

For a more in depth understanding of LIFO and a comparison to FIFO, check out our blog on the subject.