What Is The LIFO Definition In Inventory Management?
LIFO (Last-In-First-Out) is a method used in inventory management that follows the rule of selling the stock that arrived the latest first. This means, that the inventory that arrived the latest in the warehouse, will be the one that gets sold the fastest. LIFO definition can be also spotted in other branches, like accounting.
Using the LIFO method can be beneficial when prices are rising because companies can take advantage of lower taxes. It’s used by businesses that sell products that are affected by inflation, like pharmaceuticals, thus they can better match their revenues to their latest costs. The LIFO method can bring some tax benefits due to profitability impacts on the income statement. This depends on the cost of every unit as well as the timing of inventory transactions.
This method is more complex to understand as well as to be applied. Additionally, in countries that follow International Financial Reporting Standards (IFRS), the use of this method is banned. The U.S. is the only country that allows the LIFO method to be applied.
Knowing the LIFO definition is not enough in inventory management. It’s also important to understand how it can be used in practice. Here’s an example:
A business that sells keychains purchases units every year. In 2017, the business received 150 keychains for 1 dollar each. In 2018 and 2019 the company purchased another 150 keychains each year which comes to 300 in total. Due to inflation, the price rose to 1.10 in 2018 and 1.15 in 2019. In 2020 the company sold 350 units. With the LIFO method, this means that the first 150 units cost 172.5 dollars, the next 150 units were 165 dollars, and the last 50 units cost 50 dollars. The total cost of that order comes to 387.5 dollars.