Cost Accounting with the Last-In, First-Out (LIFO) Method
In cost accounting, the last-in, first-out method assumes that you sell the most recent inventory items first. Take a look at this table. Because prices increased during the month, the last items purchased are more expensive than the first items purchased.
|Date||Units Purchased||Price Per Unit||Total|
|Total Units||325||Total Cost||$3,925|
For LIFO, you start at the bottom of the table and work your way up. You sell the most recent purchases first. With LIFO, you sell the 75 units you bought on 10/17 at $15 first. When you sell all 75 of the 10/17 units, you’re “movin’ on up.” The next units are the units you bought on 10/15 at $12.
The second table shows cost of sales using the LIFO method.
|Date||Units Sold||Price Per Unit||Total|
|Total Units||100||Total Cost||$1,425|
Start at the bottom of the first table. On 10/25, you sell 50 units. These are units you bought for $15 on 10/17. On 10/31, you sell another 50 units. For the remaining 50 units sold, you first sell the remaining 25 units at $15 (the 10/17 purchases). Then you move up one spot in the table. You sell 25 of the units you bought for $12 on 10/15. To fill the entire sale order of 100 units, you pulled units from two different purchase dates.
You’re not selling the actual physical units from a particular purchase date. They all look the same in the stockroom or on the shelf. You’re just using a costing method, assuming that the units sell as though they were from a particular purchase date.
The number of units sold (100) will be the same whether you’re using first-in, first-out (FIFO) or LIFO. The inventory method you choose has no impact on the movement of units; however, your cost of sales will be different. This is to be expected because LIFO sells the more recent (and more expensive) units first, you’d expect the LIFO cost of sales to be higher.
Here is the movement of dollars for LIFO:
Ending inventory = dollars to account for – dollars for units sold
Ending inventory = $3,925 – $1,425
Ending inventory = $2,500
Because LIFO’s cost of sales is higher, the ending inventory will be lower because what’s left on the shelf is less valuable.