Last-In, First-Out (LIFO) Method
The last-in, first-out (LIFO) method of costing inventories on the assumption that the costs of the last items purchased should be assigned to the first items used or sold and that the cost of the ending inventory reflects the cost of merchandise purchased earliest.
| Date | Transaction | Number of Items | Unit Cost | Total Cost | |
|---|---|---|---|---|---|
| June | 1 | Beginning Inventory | 50 | $1.00 | $50.00 |
| June | 6 | Purchased | 50 | 1.10 | 55.00 |
| June | 13 | Purchased | 150 | 1.20 | 180.00 |
| June | 20 | Purchased | 100 | 1.30 | 130.00 |
| June | 25 | Purchased | 150 | 1.40 | 210.00 |
| Totals | 500 | $625.00 | |||
Ending inventory: 220 units
50 units at $1.00 from the June 1 inventory 50 * 1.00 $50.00
50 units at $1.10 from purchase of June 6 50 * 1.10 55.00
120 units at $1.20 from purchase of June 13 120 * 1.20 144.00 220 units at a cost of $249.00
Cost of Goods Available for Sale $625.00
Less June 30 Inventory 249.00 Cost of Goods Sold $376.00
The effect of LIFO is to value inventory at earliest prices and to include in cost of goods sold the cost of the most recently purchased goods. This assumption, of course, does not agree with the actual physical movement of goods in most businesses.
There is a strong logical argument to support this method, based on the fact that a certain size inventory is necessary in a going concern. When inventory is sold, it must be replaced with more goods. The supporters of LIFO reason that the fairest determination of income occurs if the current costs of merchandise are matched against current sales prices, regardless of which physical units of merchandise are sold. When prices are moving either upward or downward, LIFO will mean that the cost of goods sold will show costs closer to the price level at the time the goods were sold. As a result, the LIFO method tends to show a smaller net income during inflationary times and a larger net income during deflationary times than other methods of inventory valuation.
The criticism of the LIFO method is that the inventory valuation on the balance sheet reflects the earlier prices. The inventory value on the balance could be unrealistic with the true value of the inventory. Therefore, balance sheet measurements such as working capital and current ratio may be distorted and must be interpreted carefully.