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 Liquidation

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

    Dollar-value LIFO is an accounting method used for inventory ...
  3. Flow Of Costs

    Refers to the manner in which costs move through a firm. Typically, ...
  4. First In, First Out - FIFO

    An asset-management and valuation method in which the assets ...
  5. Ending Inventory

    Ending inventory is a common financial metric measuring the final ...
  6. Accounting Policies

    The specific policies and procedures used by a company to prepare ...
Related Articles
  1. 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.
  2. Investing

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
  3. Insights

    What You Should Know About Inflation

    Find out how this figure relates to your investment portfolio.
  4. Investing

    Understanding Periodic vs. Perpetual Inventory

    An overview of the two primary inventory accounting systems.
  5. Investing

    How to Calculate Average Inventory

    Average inventory is the median value of an inventory at a specific time period.
  6. Investing

    Don't Lose Your Shirt On Mutual Fund Sales

    Mutual funds aren't guaranteed profit-makers, but with the right calculations and timing, you can avoid major losses.
  7. Investing

    Spotting Creative Accounting on the Balance Sheet

    Companies have used creative accounting as a way of manipulating their balance sheets.
  8. Taxes

    Capital Gains Tax 101

    Find out how taxes are applied to your investment returns and how you can reduce your capital gain tax burden.
  9. Trading

    How Companies Use Derivatives to Hedge Risk

    Derivatives can reduce the risks associated with changes in foreign exchange rates, interest rates and commodity prices.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. What is the difference between marginal benefit and marginal revenue?

    Understand the difference between marginal benefit and marginal revenue, and learn how each is maximized. Read Answer >>
  5. How does inventory accounting differ between GAAP and IFRS?

    Learn about inventory costing differences between generally accepted accounting principles, or GAAP, and International Financial ... Read Answer >>
Hot Definitions
  1. Receivables Turnover Ratio

    Receivables turnover ratio is an accounting measure used to quantify a firm's effectiveness in extending credit and in collecting ...
  2. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  3. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  4. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  5. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  6. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
Trading Center