LIFO (Last in First Out)

LIFO (Last in First Out)

LIFO (Last in First Out)

One of the most important and controversial flow assumptions is the LIFO method. The LIFO method is based on the basic assumption that the most recently acquired units are sold first and that older units remain in inventory. This notion opposes the physical movement of goods in most firms. However, there are solid logical reasons in favor of the LIFO approach, in addition to income tax considerations.

Most accountants see the movement of costs as more significant than the actual flow of products for calculating income. Supporters of the LIFO approach argued that income should be calculated based on current market circumstances. Therefore, current sales income should be offset by the current cost of goods sold.

The costs allocated to the cost of products sold under the LIFO technique are relatively current since they derive from the most recent purchases. The FIFO approach, on the other hand, bases the cost of items sold on “older” costs.

However, income tax considerations are the primary reason for the LIFO method’s popularity. Keep in mind that the LIFO technique applies the most recent inventory purchase costs to the cost of goods sold.

In a rising-priced environment, the ‘most recent’ costs are also the greatest. The LIFO technique typically results in lower taxable income because it reports a greater cost of goods sold than the other inventory valuation methods. In summary, if inventory costs are growing, a business can minimize its income tax liability by employing the LIFO technique in its income tax return.

There is one big flaw in the LIFO technique. The asset inventory is valued using the company’s “oldest” inventory purchase costs. After many years in business, these “oldest” costs may drastically understate the current replacement cost of the inventory.

Example:

Receipts:

07 March 20–, 15 units @ Rs. 130 per unit

08 March 20–, 25 units @ Rs. 140 per unit

27 March 20–, 30 units @ Rs. 150 per unit

Issues:

25 March  20–, 10 units

26 March 20–, 15 units

28 March 20–, 20 units

Valuation of Stock by LIFO Method

DateReceiptIssuesAmountValue of StockTotal Amount
07 March15 units @ Rs. 130 per unit195015 x 130 = 19501950
08 March 25 units @ Rs. 140 per unit350015 x 130 = 1950
25 x 140 = 3500
5450
25 March10 Units140015 x 130 = 1950
15 x 140 = 2100
4050
26 March15 Units210015 x 130 = 1950
0 x 140 = 0
1950
27 March30 units @ Rs. 150 per unit450015 x 130 = 1950
30 x 150 = 4500
6450
28 March20 Units300015 x 130 = 1950
10 x 150 = 4500
3450

We also have:

FIFO (First in First Out)

What is Inventory Valuation

What is Inventory in Accounting

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