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LIFO

Author: Sophia
PDF Version

what's covered
This tutorial will cover the inventory cost flow assumption known as LIFO, which is an acronym for Last In First Out.

Our discussion breaks down as follows:

Table of Contents

1. LIFO

LIFO is an inventory valuation method, which stands for Last In First Out:

As an inventory valuation method, LIFO helps to provide information about cost of goods sold and ending inventory. Under LIFO, goods are assumed to be sold newest to oldest, meaning goods that were purchased last or most recently are the first to be sold. The oldest goods, or goods that were purchased first, are assumed to remain in inventory.

The argument for using LIFO centers on matching current costs with current revenues. Newer purchases, which represent current costs, are recorded as cost of goods sold, and that expense is matched with current revenues.

2. LIFO and Cost of Goods Sold

Next, let's discuss LIFO and costs of goods sold. We will start by revisiting the cost of goods sold calculation, which starts with beginning inventory, then we add costs of goods purchased to give us goods available for sale. Then, we subtract out ending inventory to equal cost of goods sold.

Let's look at an example of calculating cost of goods sold using the inventory valuation method of LIFO. Below you will see a spreadsheet outlining the cost of goods sold calculation. We will begin with the first line, beginning inventory. Beginning inventory is pulled from our balance sheet or from our trial balance. You can also see there is a schedule, detailing beginning inventory and purchases.

Once we have plugged in beginning inventory, we need to determine cost of goods purchased. If you look at the detail of all the purchases made, you can see that we made three purchases throughout the year.

We can take the total of those purchases, which is $5,400, and drop that into the schedule, which means we now have total goods available for sale of $5,900. Note that this is the total of beginning inventory plus all of the purchases.

Now we need to know what our ending inventory is. If you look at the ending inventory schedule below, we're going to make the assumption that we have 100 units left in our ending inventory.

Using LIFO means that the last units in are the first ones out--that the most recent purchases are the purchases that our sales came from. In turn, this means that the oldest units are what comprise our ending inventory.

This table titled

Therefore, we can take 50 units in our beginning inventory on January 1, our oldest units, and work our way forward through our purchases. We can take another 50 units from the purchase made on April 1. Once we have that information, we can total our ending inventory, which is $1,100, based on those 100 units.

Then, we take that number and drop it into our cost of goods sold schedule to calculate our cost of goods sold, which in this case is $4,800.

The cost of goods sold is $4800.

IN CONTEXT

Consider the following table:

Beginning Inventory and Purchases
Purchased Units Unit Cost Total Cost
Beginning Inventory 100 $5 $500
September 120 $6 $720
October 140 $7 $980
November 130 $8 $1,040
Units Available For Sale 490 $3,240
Ending Inventory
Units on Hand 290 Cost of Units on Hand $
Units Sold 200 Cost of Goods Sold $


Using the LIFO method and the information in this table, what is the cost of units on hand and cost of goods sold during this period?

First, find the ending inventory. With LIFO, the ending inventory is going to be our oldest units. We have 290 items on hand, which means we will take all 100 units from the beginning inventory, all 120 units from September, and 70 units from October:

table attributes columnalign left end attributes row cell B e g i n n i n g space I n v e n t o r y colon space 100 times $ 5 equals $ 500 end cell row cell S e p t e m b e r colon thin space 120 times $ 6 equals $ 720 end cell row cell O c t o b e r colon space 70 times $ 7 equals $ 490 end cell row cell E n d i n g space I n v e n t o r y colon space $ 500 plus $ 720 plus $ 490 equals $ 1 comma 710 end cell end table

The ending inventory, or cost of units on hand, for these 290 items is $1,710. Now we can subtract this value from the goods available for sale to find the cost of goods sold.

table attributes columnalign right end attributes row cell G o o d s space A v a i l a b l e space f o r space S a l e end cell row cell space space stack space space space space space space space space space space minus space E n d i n g space I n v e n t o r y with bar below end cell row cell C o s t space o f space G o o d s space S o l d end cell row blank row cell $ 3 comma 240 end cell row cell space space stack space space minus space $ 1 comma 710 with bar below end cell row cell $ 1 comma 530 end cell end table

The cost of goods sold using LIFO method is $1,530.

Beginning Inventory and Purchases
Purchased Units Unit Cost Total Cost
Beginning Inventory 100 $5 $500
September 120 $6 $720
October 140 $7 $980
November 130 $8 $1,040
Units Available For Sale 490 $3,240
Ending Inventory
Units on Hand 290 Cost of Units on Hand $1,710
Beginning Inventory 100 $5 $500
September 120 $6 $720
October 70 $7 $490
Units Sold 200 Cost of Goods Sold 1,530
October 70 $7 $490
November 130 $8 $1,040

summary
Today we learned about LIFO, Last In First Out, which is an inventory valuation method that helps to provide information about cost of goods sold and ending inventory. Under LIFO, goods are assumed to be sold newest to oldest, so the goods that were purchased last are the first to be sold, and the oldest goods are assumed to remain in ending inventory. We also performed a calculation of cost of goods sold using LIFO.

Source: Adapted from Sophia instructor Evan McLaughlin.

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