What is LIFO?
LIFO, or Last-In, First-Out, is an inventory management method where the most recently produced or purchased items are sold first. This approach is contrary to FIFO and is often used for accounting purposes, especially in industries where product value doesn’t degrade over time.
LIFO is less favorable for perishable goods or items subject to technological obsolescence, where selling older inventory first is crucial to maintaining product integrity and relevance.
Functioning Principle of LIFO
Under LIFO, the newest stock is considered for sales before the older inventory.
In financial accounting, LIFO can reduce tax liabilities in periods of inflation, as the cost of goods sold is higher when newer, more expensive inventory is sold first.
Imagine a hardware store that regularly stocks up on hammers. In January, they buy 100 hammers at $10 each. In June, due to increased demand, they buy another 100 hammers, but now at $12 each due to price inflation. Using LIFO, when a customer buys a hammer after June, the store sells from the June batch first, despite having older stock from January.
Top 4 Benefits of LIFO:
1. Better Match of Current Costs and Revenues
LIFO can provide a more accurate match between current costs (recent purchase prices) and revenues, particularly in times of inflation.
2. Tax Efficiency
In inflationary periods, LIFO leads to higher cost of goods sold and lower reported profits, potentially resulting in lower tax liabilities.
3. Inventory Cost Management
Helps businesses manage costs effectively during times of rising prices by selling more expensive, recently acquired inventory first.
4. Adaptability in Certain Industries
Useful in industries where product value doesn't degrade over time, allowing for flexibility in inventory management.
Which Businesses Should Use LIFO Method?
LIFO is most suitable for non-perishable goods and industries where price inflation is a concern. This includes sectors like:
Where products like steel and lumber don’t degrade quickly.
Stationery and Office Supplies
Non-perishable items where the latest acquired stock can be sold without concern for obsolescence.
For components that don’t have a shelf life and where recent purchase prices may be higher.
In cases where older versions are not necessarily inferior to newer stock.