Last In, First Out (LIFO)
LIFO (Last in, first out) is a way of product accounting in which the goods that were delivered last are sold first. There is an opposite method - FIFO, which means "first in, first out". It is described in more detail in the corresponding article on our website.
Last In, First Out (LIFO) explained
In this approach, write-offs are made in reverse order, that is, the cost of production is charged for materials at the most current prices, and the inventory remains those units of products and materials that got there in the beginning. With this approach, the company's profitability will be calculated more accurately (and in the face of rising prices will be lower), but the inventory will be calculated on the basis of completely irrelevant prices.
The LIFO method is not allowed by the International Financial Reporting Standards and is not applied in Russia and many other countries. Nevertheless, there are countries where it is allowed, and the best known case is the USA, where the LIFO method is not only possible, but is the main one in tax accounting.
Often you may encounter an increase in the price of products from a supplier. In this case, working according to the LIFO principle will show a lower profit for the last accounting period than when using the principle of selling first come, first served. Lower net income by performance can reduce tax and this reason is often the only reason to use LIFO-type product accounting.
Why the Last In, First Out (LIFO) method is rarely used
Despite the fact that using the LIFO method of operation makes logical sense - it is not a realistic way of accounting. It doesn't show a true picture of product sales and the actual profit from them.
Moreover, it can devalue old products. Last In, First Out (LIFO) accounting assumes the constant use of new goods first, which in most cases creates problems with the very first purchased goods: they spoil or lose their relevance, and simply take up space that can be successfully used for other types of products. And this is not the most efficient way of doing business.
When the Last In, First Out (LIFO) method can cause problems
Despite the pluses of tax minimization, prolonged operation under the LIFO principle can be detrimental to existing inventory and valuation. In 2009, for example, the Journal of Accountancy reported that Exxon Mobil's invalid replacement cost exceeded the value under the LIF) accounting principle by $25.4 billion. This suggests that the company's inventory is extremely depreciated due to the use of LIFO accounting for an extended period of time.
On the other hand, it was reported that the LIFO principle helped reduce the company's profit in figures by $40 million. If the business had used FIFO accounting, it would have had to pay taxes according to the company's $40 million increased profit.
