What Is LIFO?
Last in, first out (LIFO) is an inventory accounting approach that registers the most recently manufactured products as sold first.
Significance of LIFO in E-commerce Logistics
LIFO is primarily used for the Cost of Goods Sold (COGS) calculation. The significance of using LIFO in accounting is –
- Aids in lowering inventory costs – Businesses can use LIFO when inflation has increased the costs of producing goods or purchasing inventory.
- Lowering taxes – Despite the fact that LIFO can result in lower profits, it can reduce a company’s corporate tax bill.
- LIFO increases the cost of purchasing inventory over time. The cost of each unit sold is capitalized within the company’s Cost of Sales account and expensed on the income statement.
How LIFO Works
In the LIFO method, it is assumed that the most recently purchased items on the inventory are sold out first. Therefore, with this assumption in hand, the COGS is counted as the cost of the last product manufactured or purchased. Contrarily, the items produced or purchased earlier, that are yet to be sold, are marked as unsold inventory.
The market environment has a significant impact on when LIFO should be used. If prices remain stable, businesses might not need to employ this strategy. This is particularly true because LIFO bookkeeping can be considerably more complicated than FIFO, or first-in, first-out, bookkeeping, which is the more common form. This is due to the possibility that some of the earlier products are still in stock, and the determined COGS figure might not accurately reflect the actual inventory.
Use Case With LIFO
Suppose a company, ABC, purchased stock 1 containing 1000 pens at AUD 1 per piece. Subsequently, the price was inflated to AUD 2 per piece and ABC purchased stock 2 at that value.
Now, applying LIFO, ABC can calculate their COGS using the formula:
The Number of Newest Units x Their value
Thus, COGS = 1000 X AUD 2
= AUD 2000.