When Should a Company Use Last in, First Out (LIFO)? (2024)

FAQs

When should a company use LIFO? ›

During times of rising prices, companies may find it beneficial to use LIFO cost accounting over FIFO. Under LIFO, firms can save on taxes as well as better match their revenue to their latest costs when prices are rising.

Last in, first out (LIFO) is a method used to account for inventory. Under LIFO, the costs of the most recent products purchased (or produced) are the first to be expensed. LIFO is used only in the United States and governed by the generally accepted accounting principles (GAAP).

In terms of investing in accounting inventory, FIFO is usually a better method for inventory when prices are rising, and LIFO accounting is better when prices fall because more expensive products are sold first.

FIFO is more likely to give accurate results. This is because calculating profit from stock is more straightforward, meaning your financial statements are easy to update, as well as saving both time and money. It also means that old stock does not get re-counted or left for so long it becomes unusable.

LIFO can be beneficial since the most recent higher-priced items will be considered sold and removed, leaving the lower-cost items as your ending inventory. This means a higher Cost of Goods Sold, which reduces your business's taxable income.

FIFO (“First-In, First-Out”) assumes that the oldest products in a company's inventory have been sold first and goes by those production costs. The LIFO (“Last-In, First-Out”) method assumes that the most recent products in a company's inventory have been sold first and uses those costs instead.

What is an example of LIFO? An example of LIFO (Last In, First Out) would be a stack of plates. The last plate placed on the stack would be the first plate taken off.

LIFO allows a business to deduct the most recently purchased items of inventory which in times of price inflation allows for a greater cost of goods sold deduction than could be realized under the FIFO method.

While there are no GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards) restrictions on the use of FIFO, the use of LIFO is prohibited. That being said, the IRS allows the use of both LIFO and FIFO.

Why do companies not use LIFO? ›

IFRS prohibits LIFO due to potential distortions it may have on a company's profitability and financial statements. For example, LIFO can understate a company's earnings for the purposes of keeping taxable income low. It can also result in inventory valuations that are outdated and obsolete.

By using this method, you'll assume the most recently produced or purchased items were sold first, resulting in higher costs and lower profits, all while reducing your tax liability. LIFO is often used by gas and oil companies, retailers and car dealerships.

LIFO results in a more accurate valuation of ending inventory on the balance sheet than does FIFO. LIFO matches cost of goods sold to sales on the income statement more accurately than does FIFO.

The companies that decide to use LIFO over FIFO most often do it for the tax advantages. However, there can also be tax liabilities. The advantages of LIFO are also its disadvantages as the only real purpose of instituting LIFO is to avoid paying higher taxes but this means profits are generally lower.

The word LIFO stands for Last In First Out, in which we will enter the data elements into the data structure. Here, we will pop out the data elements which are recently added. It means that the last element will be the first to be popped out. Another best example real-life example is the Tower of Hanoi.

LIFO = Last In First Out

Working according to the LIFO principle means that the last goods to be stocked are the first goods to be removed.

Walmart uses different costing methods in order to reduce inventory costs and providing accurate product costs. These costing methods are “Last In First Out” (LIFO) and “First In First Out” (FIFO). Walmart's annual report [43] shows how the company uses LIFO to calculate the average weighting cost for US products.

Example of FIFO

Imagine if a company purchased 100 items for $10 each, then later purchased 100 more items for $15 each. Then, the company sold 60 items. Under the FIFO method, the cost of goods sold for each of the 60 items is $10/unit because the first goods purchased are the first goods sold.

In 2021, approximately 15% of companies in the S&P 500 used LIFO as their primary inventory method and 50% used FIFO, according to Credit Suisse Group AG, citing annual reports.

Most companies prefer FIFO to LIFO because there is no valid reason for using recent inventory first, while leaving older inventory to become outdated. This is particularly true if you're selling perishable items or items that can quickly become obsolete.

What is an example of a business that uses LIFO and an example of a business that uses FIFO? ›

Just to name a few examples, Dell Computer (NASDAQ:DELL) uses FIFO. General Electric (NYSE:GE) uses LIFO for its U.S. inventory and FIFO for international. Teen retailer Hot Topic (NASDAQ:HOTT) uses FIFO. Wal-Mart (NYSE:WMT) uses LIFO.

LIFO results in lower net income because the cost of goods sold is higher, so there is a lower taxable income.” Reduced tax liability is a key reason some companies prefer LIFO. “By using more recent inventory in valuation, your cost basis is higher on current income statements,” Melwani said.

Through LIFO, the main advantage lies in reporting lower profits, getting around financial analysis. It is more apt for cash accounting, inventory purchase, matching cost revenue figures and allowing a complete recovery of material cost. It helps to validate the published financials and the income statement.

Last-In, First-Out (LIFO) inventory deductions allow companies to deduct the cost of inventory at the price of the most recently acquired items and assumes that the last inventory purchased is the first to be sold. LIFO limits the impacts of volatile prices or inflation and lowers the tax cost of new inventory.

LIFO results in lower inventory costs on the balance sheet because the latest, higher costs were removed from inventory ahead of the older lower costs. LIFO means that the cost of goods sold on the income statement will contain the higher most recent costs.