{"id":2124,"date":"2021-11-26T11:00:00","date_gmt":"2021-11-26T11:00:00","guid":{"rendered":"https:\/\/www.shipbob.com\/au\/blog\/lifo\/"},"modified":"2025-12-24T20:05:11","modified_gmt":"2025-12-24T20:05:11","slug":"lifo","status":"publish","type":"blog","link":"https:\/\/www.shipbob.com\/au\/blog\/lifo\/","title":{"rendered":"What Is LIFO and How Can It Be Used?"},"content":{"rendered":"\n

Table of Contents<\/p>

** Minutes<\/p><\/div><\/div>\n

What is LIFO?<\/a><\/p>\n\n\n\n

LIFO vs FIFO<\/a><\/p>\n\n\n\n

What method of inventory management should you use?<\/a><\/p>\n\n\n\n

How to switch to LIFO<\/a><\/p>\n\n\n\n

Leave inventory management to the pros<\/a><\/p>\n\n\n\n

LIFO FAQs<\/a><\/p>\n\n\n\n

<\/a><\/p>\n<\/div>\n\n\n\n

Imagine this scenario:<\/p>\n\n\n\n

Jordan operates an online furniture company that holds luxury furniture inventory in a large warehouse.<\/p>\n\n\n\n

Recently, Jordan purchased 20 sofas at $1,500 each and six months later, another 20 units of the same sofa at $1,700 each. <\/span><\/p>\n\n\n\n

To calculate ending inventory value, Jordan took into account the cost of the latest inventory purchase at $1,700, despite the newer inventory still being on hand.<\/span><\/p>\n\n\n\n

This might seem backwards to most businesses, but Jordan uses LIFO, an inventory valuation method<\/a> that is less common but is legal in the US.<\/span><\/p>\n\n\n\n

When Jordan opened the business, he decided that LIFO made the most sense.<\/span> <\/span>But that\u2019s not to say it\u2019s beneficial for all businesses. <\/span><\/p>\n\n\n\n

LIFO, like other inventory valuation methods, has advantages and disadvantages. <\/span><\/p>\n\n\n\n

When is LIFO used? What are its pros and cons? How does it differ from other methods? In this article, we break down what the LIFO method entails, how it works, and its use cases.<\/p>\n\n\n\n

What is LIFO?<\/h2>\n\n\n\n

LIFO, which stands for last in, first out, is an inventory valuation method that uses the cost of the most recent products purchased to calculate the cost of goods sold (COGS)<\/a>, while older inventory value is considered ending inventory on a balance sheet.<\/span><\/p>\n\n\n\n

Though LIFO is accepted under the Generally Accepted Accounting Principles (GAAP), unlike the more common valuation methods, such as FIFO or weighted average cost<\/a>, the International Financial Reporting Standards (IFRS) forbids the use of the LIFO method.<\/p>\n\n\n\n

How the last in, first out method of inventory management works<\/h3>\n\n\n\n

The LIFO method assumes that the most recently purchased inventory items are the ones that are sold first. <\/span><\/p>\n\n\n\n

With this cash flow assumption, the costs of the last items purchased or produced are the first to be counted as COGS. Meanwhile, the cost of the older items not yet sold will be reported as unsold inventory.<\/span><\/p>\n\n\n\n

To further understand how LIFO works, let\u2019s imagine a vitamin and supplement<\/a> brand that secured 3 batches of the same supplement over a course of 3 weeks. <\/span><\/p>\n\n\n\n

Batch<\/b><\/td>Units<\/b><\/td>Purchase date<\/b><\/td><\/tr>
Batch 1<\/b><\/td>10<\/span><\/td>Week 1<\/span><\/td><\/tr>
Batch 2<\/b><\/td>20<\/span><\/td>Week 2<\/span><\/td><\/tr>
Batch 3<\/b><\/td>40<\/span><\/td>Week 3<\/span><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

In week 4, a customer placed an order for 25 of these supplement bottles.<\/span><\/p>\n\n\n\n

As per LIFO, the business dispatches 25 units from Batch 3 (the newest inventory) to the customer. <\/span><\/p>\n\n\n\n

This brings the ending inventory balance in the warehouse to:<\/span><\/p>\n\n\n\n

Batch<\/b><\/td>Units<\/b><\/td><\/tr>
Batch 1<\/b><\/td>10<\/span><\/td><\/tr>
Batch 2<\/b><\/td>20<\/span><\/td><\/tr>
Batch 3<\/b><\/td>15<\/span><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

Though LIFO is considered an inventory management<\/a> process, it\u2019s important to keep in mind that calculating inventory value doesn\u2019t always follow the actual flow of inventory from being received to being sold. <\/span><\/p>\n\n\n\n

However, for accounting purposes, as long as you remove COGS from the last inventory replenishment<\/a> cycle under LIFO, it (technically) doesn\u2019t matter if you sell the oldest or latest inventory items first.<\/span><\/p>\n\n\n\n

To understand further how LIFO is calculated despite real inventory activity, let\u2019s dive into a few more examples.<\/p>\n\n\n\n

Examples of calculating inventory using LIFO<\/h3>\n\n\n\n

Let\u2019s imagine a stationery supplier, who has 300 units of pens in stock, purchased these in 3 batches of 100 units each. The cost of the first batch was $1 each unit. Due to inflation, the next two batches cost $2 each and $3 each unit, respectively. <\/span><\/p>\n\n\n\n

Batch<\/b><\/td>Unit count<\/b><\/td>Cost per unit<\/b><\/td>Total cost<\/b><\/td><\/tr>
Batch 1<\/span><\/td>100<\/span><\/td>$1<\/span><\/td>$100<\/span><\/td><\/tr>
Batch 2<\/span><\/td>100<\/span><\/td>$2<\/span><\/td>$200<\/span><\/td><\/tr>
Batch 3<\/span><\/td>100<\/span><\/td>$3<\/span><\/td>$300<\/span><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

Then, this supplier sells 200 pens. With LIFO, the inventory purchased in Batch 3 and then Batch 2 are assumed to have sold first, while Batch 1 still remains on hand. <\/span><\/p>\n\n\n\n

To calculate COGS, it would take into account the newest purchase prices.  <\/span><\/p>\n\n\n\n

\n

COGS = (The Number of Newest Units x Their Value) + (Remaining Units From the Second Purchase x Their Value)<\/p>\n\n\n\n

COGS = (100 x $3) + (100 x $2)  = $500<\/span><\/p>\n<\/blockquote>\n\n\n\n

Meanwhile, items of Batch 1 are considered unsold. <\/span><\/p>\n\n\n\n

The ending inventory value reported would be:<\/span><\/p>\n\n\n\n

\n

Ending Inventory Value = Remaining Units x Their Value<\/p>\n\n\n\n

Ending Inventory Value = 100 x $1 = $100<\/span><\/p>\n<\/blockquote>\n\n\n\n

Consider another example of a fictitious manufacturing plant, ABC Ltd, that produced 2 batches of the same SKU<\/a> with the following specifications:<\/span><\/p>\n\n\n\n

Batch<\/b><\/td>Unit count<\/b><\/td>Cost per unit<\/b><\/td>Total cost<\/b><\/td><\/tr>
Batch 1<\/span><\/td>5<\/span><\/td>$20<\/span><\/td>$100<\/span><\/td><\/tr>
Batch 2<\/span><\/td>30<\/span><\/td>$30<\/span><\/td>$900<\/span><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

If the manufacturing plant were to sell 10 units, under the LIFO method it would be assumed that part of the most recently produced inventory from Batch 2 was sold. So, the COGS will be a total cost of 10 units at $30 each.<\/span><\/p>\n\n\n\n

\n

COGS = The Number of Newest Units x Their Value<\/p>\n\n\n\n

COGS = 10 x $30 = $300  <\/span><\/p>\n<\/blockquote>\n\n\n\n

The ending inventory value is then calculated by adding the value of Batch 1 and the remaining units of Batch 2.<\/span><\/p>\n\n\n\n

\n

Ending Inventory Value = Remaining Units x Their Value<\/p>\n\n\n\n

Ending Inventory Value = (5 x $20) + (20 x $30) = $700<\/span><\/p>\n<\/blockquote>\n\n\n\n

LIFO vs FIFO<\/h2>\n\n\n\n

US companies may choose between the LIFO or the FIFO method<\/a> (there are other methods too, but for now, we\u2019ll focus on the comparison of these two).<\/span><\/p>\n\n\n\n

Though both are legal to use in the United States, LIFO is considered to be more complex and is less favored. Ideally, LIFO is used when a business\u2019s <\/span>COGS tend to be higher and profits are lower. When this is the case, a business using LIFO will pay less in taxes.<\/p>\n\n\n\n

Here is a quick overview of the differences between the two inventory accounting practices:<\/p>\n\n\n\n

LIFO method<\/strong><\/td>FIFO method<\/strong><\/td><\/tr>
Stands for \u201cLast-In, First-Out\u201d<\/span><\/td>Stands for \u201cFirst-In, First-Out\u201d<\/span><\/td><\/tr>
Assumes the latest inventory units are sold first<\/span><\/td>Assumes the oldest inventory units are sold first<\/span><\/td><\/tr>
Is especially useful during inflation, as it results in lower net income as compared to FIFO<\/span><\/td>Is not as useful during inflation, as it results in higher net income as compared to LIFO<\/span><\/td><\/tr>
Can only be used in the US, since it is banned by the IFRS <\/span><\/td>Can be used by global businesses since its approved by the IFRS<\/span><\/td><\/tr>
Not recommended for perishable or time-sensitive goods<\/span><\/td>Can be used for all kinds of goods, but provides a dual advantage when selling items prone to going obsolete quickly or obtain an expiry date<\/span><\/td><\/tr>
Understates the value of <\/span>ending inventory<\/span><\/td>More accurately values ending inventory <\/span><\/td><\/tr>
Not a commonly used method since the accounting process is more complex and is often linked to manipulating income to secure unfair tax benefits<\/span><\/td>Is usually the most widely used and accurate accounting method, since the flow of costs and goods are often aligned<\/span><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

What method of inventory management should you use?<\/h2>\n\n\n\n

When prices are rising, it can be beneficial for companies to use LIFO since COGS associated with its newest inventory is accounted for, rather than older inventory. Many companies that hold large quantities of high-priced inventory may use LIFO (such as a furniture store or an auto dealership).<\/p>\n\n\n\n

Every business deals with price increases, inflation, and holding inventory that loses its value over time, but LIFO is ideal for businesses that carry pricier inventory that tend to lose its value substantially year after year.<\/p>\n\n\n\n

That\u2019s why auto dealerships are a great example of why LIFO is used; the moment a new car is driven, it loses value. But that\u2019s not to say used cars are not in high demand.<\/p>\n\n\n\n

However, if an auto dealership used FIFO rather than LIFO, it would most likely showcase major discrepancies in ending inventory value.<\/p>\n\n\n\n

If you consider the typical online business, LIFO isn\u2019t widely used. The biggest criticism that LIFO faces is the claim that it distorts inventory value on a balance sheet in times of high inflation. Critics of this method also point out that LIFO offers an unfair tax break, since it provides a higher tax cut.<\/p>\n\n\n\n

That\u2019s why, for most online brands especially, the FIFO method is most commonly used, as it makes <\/span>calculating inventory value much easier and often matches the natural flow of inventory throughout an ecommerce supply chain. <\/a><\/p>\n\n\n\n

Another benefit of FIFO is that you\u2019re able to track and regulate quality and offset the risk of high holding costs<\/a> for storing dead stock<\/a>.<\/p>\n\n\n\n

But that\u2019s not to say LIFO might not make sense for your business. If you\u2019re considering LIFO, be sure to have a conversation with your CPA. You will also need to follow a process to legally switch to LIFO.<\/p>\n\n\n\n

How to switch to LIFO<\/h2>\n\n\n\n

To use the LIFO method, you will need permission from the IRS to switch from the default FIFO (or any other method) to the LIFO method.<\/span><\/p>\n\n\n\n

To elect for the LIFO <\/span>inventory accounting<\/span><\/a> method, you must fill in and submit <\/span>Form 970<\/span><\/a>, along with your tax returns in the year you first implemented LIFO. It\u2019s best to consult your CPA throughout this process. <\/span><\/p>\n\n\n\n

Within your application, make sure to include:<\/span><\/p>\n\n\n\n