LIFO Method Formula
Last In First Out (LIFO) is an inventory valuation that refers to selling the items that arrive last to the warehouse first. In simpler words, the latest commodities received at the location are removed or sold first.
Significance of the LIFO Method Formula
Companies use FIFO as its prefered inventory valuation method. But LIFO on the other hand holds utmost importance as it is beneficial in the following ways:
- LIFO helps in producing high costs of selling goods (COGS)
- It leads to a lower balance of leftover inventory
- It also saves taxes because of a lower profit margin (in case of inflation)
Applications of LIFO Method Formula
LIFO is more appropriate for those businesses that have regular supplies of goods to stock out all the items in their inventory. Using the LIFO method helps companies determine in several ways, which include:
- The LIFO method helps companies match their revenue to the latest cost when prices rise
- It saves tax as the COGS is higher and the taxable income becomes low
LIFO Method Formula
LIFO method formula =
Cost of Recent Inventory X Amount of Inventory Sold
Understanding With the Help of an Example
Suppose you bought stocks of tablets (or tabs) at different prices at different times. You received the first stock of 10 tablets for $1000 each. Then you received the second stock after the first one with five tablets for $1100 each. You received an order for four tablets. Now, look at the calculation part-
Going by the LIFO method, the second stock, the newest one, will be taken out first. Therefore-
4 tablets of $1100 each= 4*1100= S$4400.
This is the total cost of total items sold, which is four.
There are still ten tablets in the first stock and one in the second available. Calculating the accounting balance of the inventory account, you’ll get-
10*1000= S$10000
1*1100= S$1100
1100+ 10000= S$11000 of the accounting balance of the inventory account.
Inference
LIFO is one of the inventory methods used in the inventory valuation strategy. The LIFO results in a change in net profit because of inflation and deflation. It also helps you determine the tax you have to pay as it is key to computing the cost of goods sold.