What Does LiFo Mean & How Does it Work?

Understanding LIFO (Last-In, First-Out)

What is LIFO?

LIFO, or Last-In, First-Out, is an inventory management method where the most recently acquired items are sold or used first. This approach is less common but is utilized in specific industries where companies want to match the most recent costs with current revenues. LIFO is often used in scenarios where inventory costs are rising, such as in manufacturing or raw material-based industries.

How Does LIFO Work?

Under the LIFO method, when inventory is used or sold, the cost of the most recent inventory is assigned to the cost of goods sold (COGS). As a result, the remaining inventory on the balance sheet reflects the cost of the oldest purchases. Here’s an example to demonstrate LIFO:

1. Purchase 1: 100 units at $10 each
2. Purchase 2: 100 units at $12 each
3. Sale: 150 units

Using LIFO, the COGS would be calculated as:

• 100 units from Purchase 2 at $12 = $1200
• 50 units from Purchase 1 at $10 = $500
• Total COGS: $1700

The remaining inventory would be 50 units from Purchase 1 at $10 each, totaling $500.

Advantages of LIFO

• Tax Benefits: During inflationary periods, LIFO can result in lower taxable income because COGS will be higher.
• Current Cost Matching: LIFO matches the most recent costs with current revenues, which can be more reflective of current market conditions.

Disadvantages of LIFO

• Complexity: LIFO can be more challenging to implement and maintain due to its complexity.
• Lower Inventory Value: In times of rising prices, LIFO will result in lower inventory values on the balance sheet.
• Regulatory Restrictions: LIFO is not accepted under International Financial Reporting Standards (IFRS), limiting its use globally.

Both FIFO and LIFO have their merits and drawbacks, and the choice between them depends on the specific needs and circumstances of the business. Understanding these methods can help businesses manage their inventory more effectively and make informed financial decisions. Contact ShipCarte today if you need any assistance with your shipping needs.