What is Last in First Out (LIFO)?
Last in First Out (LIFO) is a method of accounting for inventory. It assumes that the last item purchased is the first sold, so you can use it to track your inventory's value.
For example, let us say you have 5 shirts in stock. You bought them for $10 each and sold them for $15 each. With First in First Out (FIFO), you would record only $15 as income and $5 as cost of goods sold (COGS). With LIFO, however, you would record $20 as income because the last shirt you purchased was sold first — making it the most expensive shirt in stock.
In the case of the LIFO method, the value of your inventory is based on the price you paid for all of your items, not their current market value. If you use this method, then when you sell an item, you have to pay tax on its original cost and not its current value.
It is important to note that this method only applies to businesses that have inventory they store for resale.
Should I Use LIFO to Value My Business’s Inventory?
The answer is that it depends.
LIFO is a method of inventory valuation that assumes the most recent purchases are the first ones sold. As such, the value of inventory is based on the cost of goods sold rather than the original cost of inventory. This method can be used by businesses when they want to make their balance sheet look better than it really is. However, there are some situations where it makes more sense to use this method than others.
For example, if your business has been experiencing an increase in sales over time and you have purchased items at different times, it may be advantageous for you to use LIFO to value your inventory so that your income statement reflects this growth and shows higher profits than would otherwise be shown by using FIFO or another method of accounting for inventory.
How Can I Determine if Using LIFO is Right for My Business?
LIFO is a popular method of accounting for inventory, but that does not mean it is right for every business. Here are a few things to consider before you decide to use LIFO to value your business's inventory.
- Are you dealing with a large amount of inventory? If you have a lot of inventory, there is a good chance that your company will be slow to sell through it all and will have to write off any excess at the end of the year. This could cost your company money if you use LIFO rather than FIFO or weighted average cost.
- Do your products change in price frequently? If so, using LIFO might not be right for you because it tends to undervalue current products in favor of older ones that were purchased at lower prices.
- Are some products more expensive than others? If so, using weighted average cost might make more sense because it will take into account their relative costs when calculating their value — the more expensive items will be worth more than less expensive ones when calculating their total value.