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
| Date | Receipt | Issues | Amount | Value of Stock | Total Amount |
| 07 March | 15 units @ Rs. 130 per unit | 1950 | 15 x 130 = 1950 | 1950 | |
| 08 March | 25 units @ Rs. 140 per unit | 3500 | 15 x 130 = 1950 25 x 140 = 3500 | 5450 | |
| 25 March | 10 Units | 1400 | 15 x 130 = 1950 15 x 140 = 2100 | 4050 | |
| 26 March | 15 Units | 2100 | 15 x 130 = 1950 0 x 140 = 0 | 1950 | |
| 27 March | 30 units @ Rs. 150 per unit | 4500 | 15 x 130 = 1950 30 x 150 = 4500 | 6450 | |
| 28 March | 20 Units | 3000 | 15 x 130 = 1950 10 x 150 = 4500 | 3450 |
We also have:
What is Inventory in Accounting
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