5.4 Last In First Out Method LIFO
The LIFO Method¶
LIFO assumes that the most recently purchased inventory items are sold or used first. This is a crucial distinction from FIFO. While LIFO might reflect the actual physical flow in some specific situations (e.g., a pile of coal where the top layer is used first), it is primarily an accounting assumption.
Example: Perpetual Inventory with LIFO¶
Using the same purchase data as the FIFO example:
- Jan 1: 500 units @ ₹200 and 400 has to be issued.
- Feb 1: 600 units @ ₹230 and 500 has to be issued.
- Mar 1: 800 units @ ₹210 and 900 has to be issued.
- Apr 1: 1000 units @ ₹180 and 800 has to be issued.
- May 1: 700 units @ ₹220 and 500 has to be issued.
- Jun 1: 400 units @ ₹250 and 600 has to be issued.
Here's the perpetual inventory calculation using LIFO:
| Date | Transaction | Units | Rate (₹) | Value (₹) | Balance Units | Balance Rate (₹) | Balance Value (₹) |
|---|---|---|---|---|---|---|---|
| Jan 1 | Purchase | 500 | 200 | 100,000 | 500 | 200 | 100,000 |
| Jan 15 | Issue | 400 | 200 | 80,000 | 100 | 200 | 20,000 |
| Feb 1 | Purchase | 600 | 230 | 138,000 | 100 @ 200 600 @ 230 |
200 230 |
20,000 138,000 = 158,000 |
| Feb 15 | Issue | 500 | 230 | 115,000 | 100 @ 200 100 @ 230 |
200 230 |
20,000 23,000= 43,000 |
| Mar 1 | Purchase | 800 | 210 | 168,000 | 100 @ 200 100 @ 230 800 @ 210 |
200 230 210 |
20,000 23,000 168,000=211,000 |
| Mar 15 | Issue | 900 | 800 @ 210 100 @ 230 |
191,000 | 100 | 200 | 20,000 |
| Apr 1 | Purchase | 1000 | 180 | 180,000 | 100 @ 200 1000 @ 180 |
200 180 |
20,000 180,000=200,000 |
| Apr 15 | Issue | 800 | 180 | 144,000 | 100 @ 200 200 @ 180 |
200 180 |
20,000 36,000=56,000 |
| May 1 | Purchase | 700 | 220 | 154,000 | 100 @ 200 200 @ 180 700 @ 220 |
200 180 220 |
20,000 36,000 154,000=210,000 |
| May 15 | Issue | 500 | 220 | 110,000 | 100 @ 200 200 @ 180 200 @ 220 |
200 180 220 |
20,000 36,000 44,000=100,000 |
| Jun 1 | Purchase | 400 | 250 | 100,000 | 100 @ 200 200 @ 180 400 @ 250 |
200 180 250 |
20,000 36,000 100,000=156,000 |
| Jun 15 | Issue | 600 | 400 @ 250 200 @ 220 |
144,000 | 100 @ 200 200 @ 180 |
200 180 |
20,000 36,000=56,000 |
Here we will first use the recent purchase to issue and then we will use the previous month's balance to issue.
Summary:
- Total Purchases: ₹840,000
- Total Issues (Material Consumption): ₹784,000
- Ending Inventory Value: ₹56,000
LIFO and Tax Implications (U.S. Only)¶
It's crucial to understand that the tax advantages of LIFO are primarily applicable in the United States. In most other countries, LIFO is not permitted for tax purposes.
LIFO Layers¶
As shown in the example, under LIFO, the ending inventory can consist of layers of inventory purchased at different costs. These layers can persist for many years, especially if inventory levels remain relatively stable or increase.
In summary, LIFO can offer tax advantages in specific circumstances (primarily in the U.S. during periods of rising prices), but it also has drawbacks, including lower reported income and a potentially unrealistic balance sheet inventory value. Its complexity and limited international acceptance make it less commonly used than FIFO.
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