LIFO Cost

LIFO Inventory Valuation Accounting Cost of Goods Sold (COGS) Financial Reporting Taxation
LIFO (Last-In-First-Out) is an inventory valuation method where the most recently produced items are considered sold first.
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Definition

LIFO Cost (Last-In-First-Out Cost) is an inventory valuation method used in financial accounting where assets produced or acquired last are the first ones to be expensed. Under LIFO, the most recently acquired inventory is used to calculate the cost of goods sold (COGS), which can impact a company’s profit, taxes, and inventory valuation on the balance sheet.

Examples

  1. Retail Industry: A clothing retailer receives new shipments every month. Under LIFO, when the retailer sells a shirt, the cost assigned to the sale would be the cost of the most recently purchased shipment.

  2. Manufacturing: A car manufacturer uses raw materials like steel that are frequently purchased. Using LIFO, the cost of goods sold for a manufactured car will be based on the cost of the most recent steel purchase.

  3. Food Industry: A grocery store that deals with both perishable and non-perishable goods might use LIFO for canned products, assuming newer stock is sold first to account for the most recent market prices in their financial reporting.

Frequently Asked Questions (FAQs)

Q1: Why do companies choose LIFO over other methods? A1: Companies may choose LIFO to match current costs with current revenues, which can result in lower taxable income during periods of rising prices.

Q2: Is LIFO accepted under all accounting standards? A2: No, LIFO is not accepted under International Financial Reporting Standards (IFRS), but it is allowed under Generally Accepted Accounting Principles (GAAP) in the United States.

Q3: How does LIFO affect the financial statements? A3: LIFO can result in lower ending inventory values and higher cost of goods sold during inflationary periods, which reduces net income.

Q4: Can a company switch between LIFO and another inventory valuation method? A4: Yes, but it typically requires permission from tax authorities, and the change must be disclosed in financial statements.

Q5: What impact does LIFO have on tax liabilities? A5: In periods of rising prices, LIFO can reduce tax liabilities because it leads to higher COGS and lower taxable income.

  • FIFO (First-In-First-Out) Cost: An inventory valuation method where the oldest inventory items are recorded as sold first.
  • Weighted Average Cost: A valuation method that averages out the cost of inventory items and assigns this average cost to both ending inventory and COGS.
  • Specific Identification Method: An inventory valuation method where the exact cost of each specific item is assigned to it.

Online References

Suggested Books for Further Studies

  1. “Accounting Principles: A Business Perspective, Financial Accounting, Chapter 7: Inventory and Cost of Goods Sold” by Hermanson, Edwards, and Maher.
  2. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield.
  3. “Financial Accounting Theory and Analysis: Text and Cases” by Richard G. Schroeder, Myrtle W. Clark, and Jack M. Cathey.

Accounting Basics: “LIFO Cost” Fundamentals Quiz

### What does LIFO stand for? - [ ] Least Inventory Fixed Ownership - [x] Last-In-First-Out - [ ] Latest Inventory Financial Order - [ ] Long Inventory File Over > **Explanation:** LIFO stands for Last-In-First-Out, which means that the most recently produced or acquired items are considered sold first. ### Under LIFO, which inventory is used first for the cost of goods sold (COGS)? - [x] The most recently acquired inventory - [ ] The oldest inventory - [ ] Average cost of all inventory - [ ] Specific identified inventory > **Explanation:** Under LIFO, the most recently acquired inventory is used first for calculating the cost of goods sold. ### What is the primary advantage of using LIFO in a period of rising prices? - [ ] It simplifies accounting records - [x] It reduces taxable income - [ ] It increases gross profit - [ ] It maximizes inventory value > **Explanation:** In a period of rising prices, LIFO reduces taxable income because higher COGS are recorded, resulting in lower net income. ### Is LIFO accepted under International Financial Reporting Standards (IFRS)? - [ ] Yes, it's universally accepted. - [ ] Yes, but only for specific industries. - [ ] Yes, if approved by the board. - [x] No, it is not accepted. > **Explanation:** LIFO is not accepted under International Financial Reporting Standards (IFRS). ### How does LIFO impact the balance sheet during inflationary periods? - [ ] Increases ending inventory value - [ ] Lowers cost of goods sold - [x] Lowers ending inventory value - [ ] Increases net income > **Explanation:** During inflationary periods, LIFO lowers the ending inventory value because the recent higher costs are expensed first, leaving older, cheaper inventory on the books. ### Can a company use both LIFO and FIFO accounting methods simultaneously? - [x] Yes, for different types of inventory. - [ ] No, it's prohibited. - [ ] Yes, without any restrictions. - [ ] Yes, but only one type per fiscal year. > **Explanation:** A company can use both LIFO and FIFO accounting methods for different types of inventory but must report it accurately. ### What must a company do if it decides to change its inventory valuation method from FIFO to LIFO? - [ ] Nothing, it can change freely. - [ ] Notify shareholders only. - [x] Obtain permission from tax authorities. - [ ] Consult with a CPA. > **Explanation:** A company must typically obtain permission from tax authorities and properly disclose the change in its financial statements when switching from FIFO to LIFO. ### Who benefits the most from the application of the LIFO method during inflation? - [ ] Stockholders - [ ] Employees - [ ] Customers - [x] The business itself in terms of tax savings > **Explanation:** The business benefits the most in terms of tax savings because LIFO reduces taxable income during inflation. ### Which industries commonly use the LIFO method? - [ ] Software development - [ ] Real estate - [ ] Service industries - [x] Retail and manufacturing > **Explanation:** Industries like retail and manufacturing commonly use LIFO to align current costs with revenues. ### What happens to the net income if LIFO is used during deflationary periods? - [ ] Increased evenly - [x] Decreases more significantly - [ ] Remains the same - [ ] Increases significantly > **Explanation:** During deflationary periods, using LIFO can result in a more significant decrease in net income because the higher cost inventories are recognized first.

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Tuesday, August 6, 2024
Lifting the Veil of Incorporation
LIFFE: The London International Financial Futures and Options Exchange
Calendar Year January 1, 1
Change in Accounting Method January 1, 1
First In, First Out (FIFO) January 1, 1
Last In, First Out (LIFO) January 1, 1
Last-In-First-Out (LIFO) Cost January 1, 1
AVCO (Average Cost Method) January 1, 1
Accounting January 1, 1
Accounting Cycle January 1, 1
Accounting Principles January 1, 1
Accounting Standards Committee (ASC) January 1, 1

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