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LIFO (Last-In, First-Out) - Periodic

🎯 Learning Objectives

  • Understand the LIFO inventory costing assumption and its rationale
  • Calculate ending inventory and COGS using periodic LIFO
  • Explain the tax advantages of LIFO during periods of rising prices
  • Describe the LIFO conformity rule and its implications
  • Compare LIFO results to FIFO and weighted average methods

📚 Background & Principles

LIFO (Last-In, First-Out) assumes that the newest inventory items are sold first, while the oldest items remain in ending inventory. This method is popular in the United States primarily for its tax benefits during periods of inflation.

Core Principle: Under LIFO, ending inventory consists of the oldest costs (the "ancient" layer), while COGS consists of the most recent costs. This creates a "first-in, still-here" effect for ending inventory.

Unlike FIFO, periodic and perpetual LIFO can produce DIFFERENT results. This is because LIFO layers are "unwound" differently depending on when sales occur.

💡 Key Insight: Think of LIFO like a coal pile. New coal gets dumped on top, and you always shovel from the TOP. The old coal at the bottom stays there for decades. LIFO keeps old, outdated costs on the balance sheet while sending new, higher costs to COGS.

🔑 Key Concepts

Last-In, First-Out (LIFO)

Inventory costing method assuming newest costs are sold first, oldest costs remain in ending inventory.

Periodic LIFO

Determining COGS and ending inventory at period-end by taking newest costs first for COGS.

Newest Costs to COGS

LIFO sends the most recent (usually highest in inflation) costs to Cost of Goods Sold.

Oldest Costs in Ending Inventory

Ending inventory reflects the oldest purchase costs, which may be decades old.

LIFO Conformity Rule

IRS requires LIFO for tax purposes ONLY if also used for financial reporting.

LIFO Reserve

Difference between FIFO and LIFO inventory values. Represents deferred taxes.

🔍 Deep Dive

Explore LIFO at different levels of depth:

🟢 Foundational Level

Understanding the LIFO concept through the coal pile analogy.

The Coal Pile Analogy

Analogy: The Industrial Coal Pile

Imagine a factory yard with a giant coal pile. Trucks arrive and dump new coal ON TOP of the pile.

Usage Pattern:

When workers need coal, they shovel from the TOP (the newest coal). They never dig to the bottom.

What Gets Used:

The LAST coal dumped on the pile is the FIRST coal used = LIFO.

What's Left:

Ending Inventory = The ancient coal at the bottom (maybe 20+ years old!).

LAST IN
Newest Costs
→
FIRST OUT
COGS
→
REMAINS
Oldest Costs

🟡 Standard Level

Calculating periodic LIFO step by step.

Periodic LIFO Calculation

Given:

Beginning Inventory: 10 units @ $10 = $100

Jan 15 Purchase: 20 units @ $12 = $240

Jan 28 Purchase: 15 units @ $15 = $225

Goods Available for Sale: 45 units = $565

Ending Inventory (physical count): 12 units

Step 1: Identify Ending Inventory Units

12 units in ending inventory come from the OLDEST purchases (LIFO = newest to COGS).

Take all 10 from Beginning @ $10, then 2 from Jan 15 @ $12.

Step 2: Calculate Ending Inventory Value

10 units × $10 = $100

2 units × $12 = $24

Total = $124

Step 3: Calculate COGS

COGS = Goods Available - Ending Inventory

COGS = $565 - $124 = $441

Date Units Unit Cost Total Cost Status
Beginning 10 $10 $100 10 in ending inventory
Jan 15 20 $12 $240 2 in ending, 18 to COGS
Jan 28 15 $15 $225 All 15 to COGS
ENDING INVENTORY (12 units) $124 (oldest costs)

🔴 Advanced Level

LIFO Reserve, tax implications, and international considerations.

LIFO Reserve Analysis

Comparing FIFO and LIFO:

FIFO Ending Inventory: $180 (newest costs)
LIFO Ending Inventory: $124 (oldest costs)
LIFO Reserve: $180 - $124 = $56
What the Reserve Means:

The $56 LIFO reserve represents additional income taxes deferred because LIFO assigns higher costs to COGS.

🚫 IFRS Prohibition

Unlike U.S. GAAP, IFRS does NOT permit LIFO.

Reason: LIFO often results in outdated inventory values on the balance sheet that don't reflect current market conditions.

🎨 Interactive: LIFO Stack Simulator

Add inventory layers and sell units to see how LIFO consumes the newest layers (top of stack) first.

Summary: 0 units, Total Cost: $0
Add inventory layers and sell to see LIFO in action.

💰 LIFO Tax Advantage (Rising Prices)

During inflation, LIFO provides significant tax benefits by matching higher recent costs with current revenue.

Higher COGS

$441
vs FIFO's $385

Lower Income

Lower
Higher expenses

Lower Taxes

$$$
Cash savings!
📊 The Trade-off: Lower reported income means lower taxes, improving cash flow. However, LIFO may make the company appear less profitable to investors and lenders.

🚫 Common Misconceptions & Professional Tips

❌ Misconception 1: "LIFO means the newest physical items are actually sold first."

✅ Reality: LIFO is a COSTING METHOD, not a physical flow assumption. Most businesses using LIFO actually sell their oldest items first. The method simply determines which costs are matched with revenue.
❌ Misconception 2: "LIFO always produces lower income than FIFO."

✅ Reality: LIFO produces lower income ONLY during RISING prices. In deflation (falling prices), LIFO would produce HIGHER income because newer (lower) costs go to COGS.
❌ Misconception 3: "Periodic and perpetual LIFO give the same results."

✅ Reality: Unlike FIFO, PERIODIC and PERPETUAL LIFO can produce DIFFERENT results. The timing of when sales occur affects which layers are "unwound" first.
💡 Professional Tip #1: The LIFO conformity rule means you can't use LIFO for taxes but FIFO for financial reporting. You're all-in or all-out on LIFO.
💡 Professional Tip #2: LIFO can create "LIFO liquidation" problems when inventory levels decline, forcing old low costs into COGS and inflating reported income unexpectedly.
💡 Professional Tip #3: When comparing companies, remember LIFO companies have older, potentially outdated inventory values on their balance sheets compared to FIFO companies.

🧠 Memory Aids & Quick Reference

⚡ Quick Recall: LIFO Rule

LIFO = Last-In, First-Out

NEWEST costs → COGS (sold)

OLDEST costs → Ending Inventory (remains)

Rising Prices = High COGS, Low Income, Low Taxes

⚫ The Coal Rule

New on top, new gets used first. Oldest remains at bottom.

📦 COGS Contains

All newest costs until all units accounted for

📦 Inventory Contains

All oldest costs (may be many years old)

📈 Rising Prices Effect

Higher COGS → Lower Income → Lower Taxes

🚫 Not Allowed Under

IFRS prohibits LIFO due to outdated balance sheet values.

📖 Glossary

Last-In, First-Out (LIFO)

Inventory costing method assuming newest costs are sold first, oldest costs remain in ending inventory.

Periodic LIFO

LIFO calculation performed at period-end after all purchases are accumulated.

LIFO Reserve

Difference between FIFO and LIFO inventory values. Represents deferred tax liability.

LIFO Conformity Rule

IRS requirement that LIFO used for tax purposes must also be used for financial reporting.

LIFO Liquidation

Problem when inventory levels decline, forcing old low costs into COGS, inflating income.

Perpetual LIFO

Applying LIFO at each sale transaction. Can differ from periodic LIFO results.

Cost Flow Assumption

Method for matching costs with revenue when specific items cannot be traced. LIFO is a cost flow assumption.

IFRS Prohibition

International accounting standards (IFRS) do not permit LIFO due to outdated inventory values on balance sheets.

🎯 Final Knowledge Check

Test your understanding of LIFO:

Question 1: Under LIFO, which costs flow to Ending Inventory?



Question 2: If prices are rising, LIFO produces:



Question 3: What is the LIFO conformity rule?



Question 4: Beginning Inventory 10 @ $10, Purchase 20 @ $12, Ending Inventory 15 units. LIFO Ending Inventory value?



Question 5: Which accounting standard prohibits LIFO?