LIFO

Intermediate

LIFO, short for last-in, first-out, is an inventory costing method that assumes the most recently purchased items are sold first, so the cost of goods sold reflects the latest prices.

LIFO is the opposite of FIFO, which assumes the oldest items are sold first. Under LIFO, the inventory left on the balance sheet is valued at older costs.

For example, a business buys 100 units at 10 each and later 100 units at 12 each, then sells 120 units. Under LIFO, the cost of goods sold is 100 units at 12 plus 20 units at 10, a total of 1,400. Under FIFO, it would be 1,240. When prices are rising, LIFO produces a higher cost of goods sold and lower reported profit.

Because lower profits mean lower taxes, LIFO has been popular with some US companies during inflation. US tax rules require companies using LIFO for tax purposes to also use it in their financial statements, known as the LIFO conformity rule.

LIFO is permitted under US GAAP but prohibited under IFRS, partly because it can leave very outdated costs on the balance sheet and does not usually reflect how goods physically move. Companies using LIFO disclose a LIFO reserve, the difference between inventory under LIFO and FIFO, which helps investors compare them with other companies.

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