What is 'Last In, First Out - LIFO'

Last in, first out (LIFO) is an asset management and valuation method that assumes assets produced or acquired last are the ones used, sold or disposed of first; LIFO assumes an entity sells, uses or disposes of its newest inventory first. If an asset is sold for less than it is acquired, then the difference is considered a capital loss. If an asset is sold for more than it is acquired, the difference is considered a capital gain.

BREAKING DOWN 'Last In, First Out - LIFO'

Using the LIFO method to evaluate and manage inventory can be tax advantageous, but it may also increase tax liability. The world of accounting is full of inventory management conventions used to help keep track of the cost and value of inventory. For this, accountants have developed two systems of inventory management: first in, first out (FIFO) and last in, first out (LIFO).

LIFO vs. FIFO

FIFO assumes the first inventory in is the first inventory sold. Grocery stores and retail outlets with perishable goods generally operate in this fashion to prevent obsolescence. LIFO is based on moving the last inventory in out first. In general, companies select the system most favorable to their tax and income situation.

LIFO vs. FIFO Example

Assume company A has 10 widgets. The first five widgets cost $100 each and arrived two days ago. The last five widgets cost $200 each and arrived one day ago. Based on the LIFO method of inventory management, the last widgets in are the first ones to be sold. Seven widgets are sold, but how much can the accountant record as a cost?

Each widget has the same sales price so revenue is the same, but the cost of the widgets is based on the inventory method selected. Based on the LIFO method, the last inventory in is the first inventory sold. This means the widgets that cost $200 sold first. The company then sold two more of the $100 widgets. In total, the company sold $1,200 worth of widgets under the LIFO method, or five at $200 and two at $100. This is in contrast to FIFO, which means the $100 widgets are sold first, followed by the $200 widgets. Using the FIFO method, the company sold $900 worth of widgets, or five at $100 and two at $200. This is why in periods of rising prices, LIFO creates higher costs and lowers net income, which also lowers taxable income. Likewise, in periods of falling prices, LIFO creates lower costs and increases net income, which also increases taxable income.

RELATED TERMS
  1. LIFO Reserve

    The difference between the FIFO and LIFO cost of inventory for ...
  2. LIFO Liquidation

    When a company using the LIFO (Last In, First Out) method of ...
  3. Dollar-Value LIFO

    An accounting method used for inventory that follows the last ...
  4. First In, First Out - FIFO

    An asset-management and valuation method in which the assets ...
  5. Flow Of Costs

    Refers to the manner in which costs move through a firm. Typically, ...
  6. Lot Relief Method

    A method of computing the cost basis of an asset that is sold ...
Related Articles
  1. Investing

    Inventory: FIFO, LIFO

    Whether a company chooses FIFO or LIFO has important implications for the bottom line and for tax liability.
  2. Investing

    When & Why Should a Company Use LIFO

    By using LIFO (last in, first out) when prices are rising, companies reduce their taxes and also better match revenues to their latest costs.
  3. Investing

    Why Last In First Out Is Banned Under IFRS (XOM)

    We explain why Last-In-First-Out is banned under IFRS
  4. Investing

    Understanding Cost Accounting

    Cost accounting is the method of financially allocating expenses to goods that are manufactured for resale. Cost accounting is also referred to as managerial accounting, because managers use ...
  5. Investing

    Inventory Valuation For Investors: FIFO And LIFO

    We go over these methods of calculating this component of the balance sheet, and how the choice affects the bottom line.
  6. Small Business

    Calculating Production Costs

    Production cost is any expense associated with manufacturing a good or providing a service.
  7. Small Business

    How Does a Perpetual Inventory System Work?

    Perpetual inventory is a system that continually tracks inventory items for quantity and availability.
  8. Investing

    What are Direct Costs?

    Direct costs for finished goods refer to the items and services directly used in production. Other costs such as rent and insurance for the production site are indirect costs. These costs may ...
  9. Insights

    What's a Producer Surplus?

    In economics, producer surplus is the difference between the price at which the producer actually sells a product and the minimum price the producer would have accepted for the product. The surplus ...
  10. Small Business

    Understanding First In, First Out (FIFO)

    A company that uses the first in, first out inventory valuation method will sell, use, or dispose of assets that it produced or acquired first.
RELATED FAQS
  1. Does US GAAP prefer FIFO or LIFO accounting?

    Investigate the use of LIFO and FIFO inventory accounting methods under U.S. GAAP, and learn why there is pressure from some ... Read Answer >>
  2. What are the business consequences of using FIFO vs. LIFO accounting methods?

    Learn about the real business consequences from using a first-in, first out inventory accounting method versus a last-in, ... Read Answer >>
  3. If during a period of rising prices, a LIFO liquidation occurs ...

    The correct answer is: b) Remember that LIFO transmits the latest prices of inventory over to cost. Therefore, what's left ... Read Answer >>
  4. What's the difference between weighted average accounting and FIFO/LILO accounting ...

    The main difference between weighted average cost accounting, LIFO, and FIFO methods of accounting is the difference in which ... Read Answer >>
  5. What are the disadvantages of the FIFO accounting method?

    Learn how the FIFO accounting method differs from the LIFO method and the primary disadvantages for a company using the FIFO ... Read Answer >>
  6. A company starts the year with five widgets in its inventory ...

    The correct answer is: C) Sales (8 units @ $1,000)   $8,000           Cost of Goods Sold (COGS):       1. Beginning Inventory: ... Read Answer >>
Hot Definitions
  1. IRS Publication 970

    A document published by the Internal Revenue Service (IRS) that provides information on tax benefits available to students ...
  2. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  3. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  4. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  5. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  6. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
Trading Center