Table of Contents
- What Is Last In, First Out (LIFO)?
- Alternatives to LIFO
- Key Takeaways on LIFO
- How LIFO Accounting Functions and Its Implications
- LIFO's Impact on Inflation and Net Income
- Real-World Example: Applying LIFO in Inventory Management
- Which Is Better, LIFO or FIFO?
- Which Is Easier, LIFO or FIFO?
- Why Is LIFO Accounting Banned in Most of the World?
- Summary: When LIFO Is Most Advantageous
What Is Last In, First Out (LIFO)?
Let me explain LIFO directly: it's a method for accounting business inventory where you record the most recently produced or purchased items as the ones sold first. This means the cost of those newest products gets expensed first as cost of goods sold (COGS), while the older, often cheaper ones stay in your reported inventory.
Alternatives to LIFO
You have options beyond LIFO, such as first in, first out (FIFO), where the oldest items get sold first, or the average cost method, which calculates a weighted average of all items to determine your costs.
Key Takeaways on LIFO
Understand that LIFO assumes your most recent inventory sells first, which directly affects cost calculations when inflation is rising. It can lower your taxable income during those periods of increasing costs, explaining why businesses with big inventories favor it. Remember, while U.S. GAAP allows LIFO, IFRS does not, so it's mostly a U.S. practice. In inflation, LIFO leads to higher COGS and lower net income, benefiting your tax situation. FIFO and LIFO yield different results—FIFO uses older costs for potentially higher taxes, while LIFO matches current costs to cut tax liabilities.
How LIFO Accounting Functions and Its Implications
LIFO is exclusive to the U.S., where GAAP lets you choose from three inventory-costing methods, but IFRS, used globally, bans it outright. If you're in retail or auto sales with large inventories, LIFO helps you cut taxable income and boost cash flow as expenses climb. It lets you leverage lower taxes and better cash when costs are on the rise. That said, most U.S. public companies stick with FIFO. If you use LIFO for taxes, you have to report financials that way too, which depresses net income.
LIFO's Impact on Inflation and Net Income
Without inflation, all methods deliver identical results, but high inflation changes everything based on your choice. FIFO gives a truer ending inventory value but inflates net income with older, lower costs, leading to higher taxes. LIFO isn't great for showing accurate inventory value—it can understate it—but it lowers net income and taxes by hiking COGS, with the bonus of fewer write-downs in inflation. Average cost sits in the middle. Flip it to deflation, and the effects reverse entirely.
Real-World Example: Applying LIFO in Inventory Management
Picture this: your company has 10 widgets—five costing $100 each, and five more at $200 arriving later. Under LIFO, the priciest, latest ones sell first. Sell seven, and your cost is $1,200: five at $200 and two at $100. Revenue stays the same regardless, but costs depend on the method. With FIFO, you'd sell the cheap ones first, recording $900: five at $100 and two at $200. That's how LIFO ramps up costs and drops net income in inflation, cutting your taxes. In deflation, it lowers costs and raises income and taxes.
Which Is Better, LIFO or FIFO?
It comes down to your business and if you're public. LIFO shrinks net income on paper, slashing taxes when inflation hits. For public companies, though, low earnings might not thrill shareholders. Companies stuck with massive inventories often pick LIFO to offset sales with high purchase prices, minimizing taxable income.
Which Is Easier, LIFO or FIFO?
Neither is more complex than the other. You can grab online calculators for both from places like OMNI Calculator to handle the math.
Why Is LIFO Accounting Banned in Most of the World?
IFRS bans LIFO worldwide because it minimizes taxable income during inflation, which governments dislike. It can also distort inventory valuations and inflate earnings during liquidation from prior LIFO use.
Summary: When LIFO Is Most Advantageous
Most firms go with FIFO for clearer inventory values and higher net income in stable times. But if you have large inventories and inflation is rising, LIFO shines by boosting COGS to cut taxes. It manages liabilities well in those scenarios, though it might not value inventory accurately and is off-limits under IFRS. Weigh your economic situation and goals when picking between LIFO and FIFO—their effects on financials are distinct.
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