Explanation :The LIFO method is most commonly applied to an organization’s inventory valuation procedures. There are a lot of different valuation methodologies applied to inventory, and often management has to make a strategic decision to determine the most advantageous method to use. Under LIFO, the valuation is structured around the concept that the last unit of inventory received (the newest inventory) is the first unit of inventory used. Depending on the unit cost and timing of inventory transactions, the LIFO method can generate a number of tax benefits due to profitability impacts on the income statement. In theory, the cost to purchase inventory will increase over time. The strategy associated with the LIFO valuation method is based on the concept of selling your most expensive inventory first. Upon selling the inventory, the value of the units sold is transferred into the Cost of Sales account and expensed on the company’s income statement.
In a nutshell :
- Last in, first out (LIFO) is a method used to account for inventory.
- Under LIFO, the costs of the most recent products purchased (or produced) are the first to be expensed.
- LIFO is used only in the United States and governed by the generally accepted accounting principles (GAAP).
- Other methods to account for inventory include first in, first out (FIFO) and the average cost method.
- Using LIFO typically lowers net income but is tax advantageous when prices are rising.