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Main / Glossary / LIFO Method Example

LIFO Method Example

The LIFO method, an abbreviation for Last In, First Out, is a widely used inventory valuation technique in the field of finance and accounting. It is primarily employed to determine the cost of goods sold (COGS) and the ending inventory of a company. Under the LIFO method, it is assumed that the most recently purchased or produced items are the first ones to be sold or used. As a result, the cost of those recently acquired items is assigned to the COGS, while the older items remain in the inventory.

To illustrate the application of the LIFO method, consider a hypothetical example involving a company that sells electronic gadgets. At the beginning of the year, the company had 100 units of a particular gadget in stock. Later in the year, it purchased an additional 200 units at a cost of $50 each. Towards the end of the year, when only 150 units remained in inventory, the company purchased another 100 units at a higher cost of $60 each.

Using the LIFO method, the cost of goods sold would be calculated by multiplying the number of units sold by their respective costs, considering the most recent purchases first. In this example, if the company sold 200 units during the year, the COGS would consist of 150 units at $60 each (the most recent purchase) and 50 units at $50 each (the earlier purchase). This results in a total COGS of $9,500 (150 x $60 + 50 x $50).

The ending inventory value, on the other hand, would be determined by multiplying the units remaining in inventory by their respective costs, again considering the most recent purchases first. In our example, the ending inventory would be calculated as 150 units at $60 each, resulting in a value of $9,000 (150 x $60).

The LIFO method example demonstrates how the costs assigned to COGS and ending inventory can differ significantly from other inventory valuation methods. Unlike the FIFO (First In, First Out) method, which assumes that the first purchased or produced items are sold first, the LIFO method can result in higher COGS and lower ending inventory value during periods of rising prices. This is because the most recently acquired items are typically more expensive than the older ones.

By using the LIFO method, companies may be able to minimize taxable income during inflationary periods since higher costs are attributed to COGS. However, it is essential to note that the LIFO method may not represent the actual physical flow of inventory in all cases.

In summary, the LIFO method is a valuable inventory valuation technique that is utilized to determine COGS and the ending inventory of a company. Through the example provided, it is evident that the LIFO method assumes the most-recently purchased or produced items are the first to be sold or used. This method has both advantages and considerations when compared to other inventory valuation methods, particularly in periods of rising prices, ultimately impacting financial reporting and tax implications.