Lesson Objectives:- Defining the LIFO method
- Calculating total inventory and cost of goods sold
- Concluding the ending inventory figure
- Why the LIFO method is no longer used
We will now talk about the LIFO inventory costing method. The acronym LIFO stands for Last in, First out which is essentially the opposite of the FIFO (First in, First Out) method.
We didn't mention this method when previously reviewing the types of inventory costing methods as it is now illegal for IFRS and ASPE standards. IFRS are international accounting standards and ASPE are accounting standards applied in Canada. This method is acceptable under the US GAAP standards and is still an important concept to accounting theory.
We will use the same list of purchase and sale transactions from the previous lessons to look at how cost of goods is calculated using the LIFO method.
First we will multiply out the units by their cost to come up with the total units and inventory costs. These calculations are listed out above and give us a total of 900 units at a cost of $2,750.
Since we are going by the last in, first out for inventory costing, we will find the cost of goods by starting with the last in unit cost. In this example, there are two sales: one for 300 units and one for 250 units.
The first 300 units would be multiplied by the last in unit cost of $4. The next 250 units would be need to be split between the $3.50 and 3 unit costs as listed above.
The totals would then be added up to come with a cost of goods sold of $2,000.
In order to calculate the ending inventory figure, we would simply subtract the cost of goods sold from the total inventory figure. This is the same way we calculated ending inventory with the FIFO method.
We can also double check this figure by multiplying out the remaining units that were not expensed. In this case, 50 units would be left at $3 and 300 units would be left at $2 for a total of $750 which matches the first calculation.
The LIFO method is no longer used for expensing inventory as it is not reflective of how inventory actually flows. This means the oldest inventory is sold first, not by last in first out. People don't normally dig to the back of the shelf when purchasing groceries, they pull the inventory from the front that was the first in.
LIFO can conclude with inaccurate or misleading net income figures. The reason for this is that often prices are inflating as opposed to following a deflationary trend. The LIFO method doesn't reflect the fact that prices are normally going up.
Take these factors into consideration when thinking about why LIFO is no longer acceptable under Canadian and international accounting standards.