Legal Definitions - LIFO accounting

LIFO accounting

Last in, first out accounting. It is a way of calculating the value of inventory, where the items that were most recently purchased are assumed to be the first ones sold. This method typically lowers the recorded value of inventory and helps businesses avoid paying higher income taxes due to inflation. It is the opposite of FIFO accounting.

Let's say a store has 10 units of a product in stock. They purchased 5 units for $10 each a month ago and 5 units for $12 each yesterday. If they sell 7 units today, according to LIFO accounting, they would assume that the 5 units purchased yesterday and 2 units purchased a month ago were sold. Therefore, the cost of goods sold would be $5 x $12 + $2 x $10 = $64.

Another example could be a car dealership that has 20 cars in stock. They purchased 10 cars for $20,000 each a month ago and 10 cars for $22,000 each yesterday. If they sell 15 cars today, according to LIFO accounting, they would assume that the 10 cars purchased yesterday and 5 cars purchased a month ago were sold. Therefore, the cost of goods sold would be $10 x $22,000 + $5 x $20,000 = $230,000.

These examples illustrate how LIFO accounting assumes that the most recently purchased items are the first ones sold, which can result in a lower recorded value of inventory and lower income taxes.