Last-in, First-out (LIFO) method is an inventory costing method that assumes the costs of the latest units purchased are the first to be allocated to cost of goods sold. Show The LIFO (last-in, first-out) method assumes that the latest goods purchased are the first to be sold. LIFO seldom coincides with the actual physical flow of inventory. (Exceptions include goods stored in piles, such as coal or ha, where goods are removed from the top of the pile as they are sold.) Under the LIFO method, the costs of the latest goods purchased are the first to be recognized in determining cost of goods sold. Under LIFO, since it is assumed that the first goods sold were those that were most recently purchased, ending inventory is based on the prices of the oldest units purchased. That is, under LIFO, companies obtain the cost of the ending inventory by taking the unit cost of the earliest goods available of sale and working forward until all units of inventory have been costed. Page 2Last-in, First-out (LIFO) method is an inventory costing method that assumes the costs of the latest units purchased are the first to be allocated to cost of goods sold. The LIFO (last-in, first-out) method assumes that the latest goods purchased are the first to be sold. LIFO seldom coincides with the actual physical flow of inventory. (Exceptions include goods stored in piles, such as coal or ha, where goods are removed from the top of the pile as they are sold.) Under the LIFO method, the costs of the latest goods purchased are the first to be recognized in determining cost of goods sold. Under LIFO, since it is assumed that the first goods sold were those that were most recently purchased, ending inventory is based on the prices of the oldest units purchased. That is, under LIFO, companies obtain the cost of the ending inventory by taking the unit cost of the earliest goods available of sale and working forward until all units of inventory have been costed. FIFO stands for "first-in, first-out", and is a method of inventory costing which assumes that the costs of the first goods purchased are those charged to cost of goods sold when the company actually sells goods. FIFO and LIFO methods are accounting techniques used in managing inventory and financial matters involving the amount of money a company has tied up within inventory of produced goods, raw materials, parts, components, or feed stocks. These methods are used to manage assumptions of cost flows related to inventory, stock repurchases (if purchased at different prices), and various other accounting purposes .
 Assumptions of FIFOThis method assumes the first goods purchased are the first goods sold. In some companies, the first units in (bought) must be the first units out (sold) to avoid large losses from spoilage. Such items as fresh dairy products, fruits, and vegetables should be sold on a FIFO basis. In these cases, an assumed first-in, first-out flow corresponds with the actual physical flow of goods. Because a company using FIFO assumes the older units are sold first and the newer units are still on hand, the ending inventory consists of the most recent purchases. When using periodic inventory procedure to determine the cost of the ending inventory at the end of the period under FIFO, you would begin by listing the cost of the most recent purchase. If the ending inventory contains more units than acquired in the most recent purchase, it also includes units from the next-to-the-latest purchase at the unit cost incurred, and so on. You would list these units from the latest purchases until that number agrees with the units in the ending inventory. How is it different?Different accounting methods produce different results, because their flow of costs are based upon different assumptions. The FIFO method bases its cost flow on the chronological order purchases are made, while the LIFO method bases it cost flow in a reverse chronological order. The average cost method produces a cost flow based on a weighted average of unit costs. The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the "LIFO reserve. " This reserve is essentially the amount by which an entity's taxable income has been deferred by using the LIFO method. How to Calculate Ending Inventory Using FIFOEnding inventory = beginning inventory + net purchases - cost of goods sold Keep in mind the FIFO assumption: Costs of the first goods purchased are those charged to cost of goods sold when the company actually sells goods. When Using FIFO
Page 2A merchandising company can prepare an accurate income statement, statements of retained earnings, and balance sheets only if its inventory is correctly valued. On the income statement, a company using periodic inventory procedure takes a physical inventory to determine the cost of goods sold. Since the cost of goods sold figure affects the company's net income, it also affects the balance of retained earnings on the statement of retained earnings. On the balance sheet, incorrect inventory amounts affect both the reported ending inventory and retained earnings. Inventories appear on the balance sheet under the heading "Current Assets," which reports current assets in a descending order of liquidity. Because inventories are consumed or converted into cash within a year or one operating cycle, whichever is longer, inventories usually follow cash and receivables on the balance sheet. FIFO and LIFO methods are accounting techniques used in managing inventory and financial matters involving the amount of money a company has tied up within inventory of produced goods, raw materials, parts, components, or feed stocks. These methods are used to manage assumptions of cost flows related to inventory, stock repurchases (if purchased at different prices), and various other accounting purposes. LIFOLIFO stands for last-in, first-out, meaning that the most recently produced items are recorded as sold first. Since the 1970s, some U.S. companies shifted towards the use of LIFO, which reduces their income taxes in times of inflation, but with International Financial Reporting Standards banning the use of LIFO, more companies have gone back to FIFO. LIFO is only used in Japan and the United States. The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the "LIFO reserve. " This reserve is essentially the amount by which an entity's taxable income has been deferred by using the LIFO method.
Determining LIFO cost of ending inventory under periodic inventory procedure.
LIFO flow of costs under periodic inventory procedure The following is an example of the LIFO inventory costing method (assume the following inventory of Product $X$ is on hand and purchased on the following dates).
The ending inventory balance on 12/31/12 balance sheet is $4\text{ units} \cdot $5 = $20$, and the cost of goods sold on the income statement is $5\text{ units} \cdot $6 + 6\text{ units} \cdot $5=$60$. LIFO Under Perpetual Inventory ProcedureUnder this procedure, the inventory composition and balance are updated with each purchase and sale. Each time a sale occurs, the items sold are assumed to be the most recent ones acquired. Despite numerous purchases and sales during the year, the ending inventory still includes the units from beginning inventory. Applying LIFO on a perpetual basis during the accounting period, results in different ending inventory and cost of goods sold figures than applying LIFO only at year-end using periodic inventory procedure. For this reason, if LIFO is applied on a perpetual basis during the period, special inventory adjustments are sometimes necessary at year-end to take full advantage of using LIFO for tax purposes. Page 3An inventory valuation allows a company to provide a monetary value for items that make up their inventory. Inventories are usually the largest current asset of a business, and proper measurement of them is necessary to assure accurate financial statements. If inventory is not properly measured, expenses and revenues cannot be properly matched and a company could make poor business decisions. A company will chose an inventory accounting system, either perpetual or periodic. In perpetual inventory the accounting records must show the amount of inventory on hand at all times. Periodic inventory is not updated on a regular basis. Methods Used to Estimate Inventory CostWhile the best way to value inventory is to perform a physical inventory, in certain business operations, taking a physical inventory is impossible or impractical. In such a situation, it is necessary to estimate the inventory cost. There are two methods to estimate inventory cost, the retail inventory method and the gross profit method. Both methods can be used to calculate the inventory amount for the monthly financial statements, or estimate the amount of missing inventory due to theft, fire or other disaster. Either of these methods should never be used as a substitute for performing an annual physical inventory. The gross profit (or gross margin) method uses the previous year's average gross profit margin (i.e. sales minus cost of goods sold divided by sales) to calculate the value of the inventory. Keep in mind the gross profit method assumes that gross profit ratio remains stable during the period.
The gross profit (or gross margin) method uses the previous year's average gross profit margin (i.e. sales minus cost of goods sold divided by sales) to calculate the value of the inventory. To prepare the inventory value via the gross profit method:
ExampleThe following is an example on how to calculate ending inventory using the gross profit method. Furniture Palace has cost of goods available for sale of $5000. Sales were $1000. The company has projected a gross profit ratio of 25%. The estimated cost of goods sold on the income statement for the period is $$1000\cdot.25 = $250$. The ending inventory on the balance sheet is $$5000 - $250=$4750$. Page 4Companies that use the specific identification method of 'inventory costing' state their cost of goods sold and ending inventory as the actual cost of specific units sold and on hand. Some accountants argue that this method provides the most precise matching of costs and revenues and is therefore the most theoretically sound method. This statement is true for some one-of-a-kind items, such as autos or real estate. For these items, use of any other method would seem illogical. However, one disadvantage of the specific identification method is that it permits the manipulation of income. Advantages and Disadvantages of FIFOThe FIFO method has four major advantages:
All the advantages of FIFO occur because when a company sells goods, the first cost it removes from inventory are the oldest unit costs. The cost attached to the unit sold is always the oldest cost. Under FIFO, purchases at the end of the period have no effect on cost of goods sold or net income ([fig:11053]]). The disadvantages of FIFO include the recognition of paper profits and a heavier tax burden if used for tax purposes in periods of inflation. An example of how to calculate the ending inventory balance of the period using FIFO -- assume the following inventory is on hand and purchased on the following dates:
Advantages and disadvantages of LIFODuring periods of inflation, LIFO shows the largest cost of goods sold of any of the costing methods because the newest costs charged to cost of goods sold are also the highest costs. The larger the cost of goods sold, the smaller the net income. Those who favor LIFO argue that its use leads to a better matching of costs and revenues than the other methods. When a company uses LIFO, the income statement reports both sales revenue and cost of goods sold in current dollars. The resulting gross margin is a better indicator of management's ability to generate income than gross margin computed using FIFO, which may include substantial inventory (paper) profits. An example of how to calculate the ending inventory balance of the period using LIFO -- assume the following inventory is on hand and purchases are made on the following dates:
Advantages and Disadvantages of Weighted-AverageWhen a company uses the weighted-average method and prices are rising, its cost of goods sold is less than that obtained under LIFO, but more than that obtained under FIFO. Inventory is not as understated as under LIFO, but it is not as up-to-date as under FIFO. A company can manipulate income under the weighted-average costing method by buying or failing to buy goods near year-end. However, the averaging process reduces the effects of buying or not buying. The following is an example of the weighted average cost method:
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Which assumed inventory cost flow method assumes that the latest units purchased are the first to be sold?
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