'Last In, First Out' (LIFO) is an inventory costing and valuation method where the most recently acquired inventory items are assumed to be sold first. Under this method, the cost of goods sold (COGS) reflects the cost of newer inventory items, while the ending inventory balance reflects the costs of older inventory items that were not sold. This can be beneficial in scenarios of rising prices, as it results in higher COGS and lower taxable income. However, the trade-off is that the inventory value on the balance sheet may appear understated.
For example, a business acquires inventory in batches over time: the earlier batches cost $10 per unit, and the later batches cost $12. If the business sells a unit of inventory under the LIFO method, the $12 batch is considered sold first and used in the calculation of COGS, leaving the $10 batch as ending inventory.
While LIFO is recognized in some accounting frameworks like U.S. GAAP, it is not permissible under standards like IFRS. This makes its applicability and usage vary depending on the regulations and the financial reporting requirements of the entity. Businesses often choose an inventory method that aligns with their financial strategy and reporting needs. Related terms include Inventory Valuation and Cost of Goods Sold (COGS).