Here Are The Understanding the LIFO Method

kelolalaut.com The LIFO (Last In, First Out) method is an inventory recording technique used in accounting to determine the value of inventory and the cost of goods sold (COGS). Under this method, the last goods purchased are assumed to be the first sold or used. In other words, the cost of the most recently purchased goods is used first in calculating COGS, while the remaining inventory consists of older goods.

How the LIFO Method Works

1. Inventory Recording:

   • When a company purchases goods, the cost is recorded based on the purchase date.
   • The most recently purchased goods are assumed to be sold first.
2. Calculating Cost of Goods Sold (COGS):
   • The LIFO method uses the cost of the newest goods in the COGS calculation.
   • Remaining inventory is valued based on older goods' costs.
3. Application in Accounting:
   • LIFO can be applied using either a perpetual system (recording every transaction in real time) or a periodic system (calculating at the end of a period).

Advantages of the LIFO Method

1. Tax Reduction During Inflation:
   • When prices rise (inflation), LIFO results in higher COGS because the newest and most expensive items are sold first. This reduces taxable income.
2. Reflects Current Costs:
   • COGS better reflects current costs, providing more relevant financial evaluations.
3. Tax Strategy:
   • Companies can reduce their tax burden under certain economic conditions.

Disadvantages of the LIFO Method

1. Does Not Reflect True Inventory Value:
   • Ending inventory is often undervalued because it uses the cost of older goods.
2. Prohibited by Some Accounting Standards:
   • The IFRS (International Financial Reporting Standards) does not allow LIFO because it does not reflect the true economic value.
3. Potential to Lower Profits:
   • In certain situations, using high COGS can reduce reported profits, which may be less appealing to investors.

LIFO Calculation Example

Suppose a company purchases inventory as follows:

• January 1: 100 units @ $50
• January 15: 100 units @ $55
• January 30: 100 units @ $60

At the end of the month, the company sells 150 units.

COGS Calculation Using LIFO:

• Last 100 units (January 30): 100 x $60 = $6,000
• Next 50 units (January 15): 50 x $55 = $2,750
  Total COGS = $8,750

Ending Inventory:

• Remaining 50 units from January 15 = 50 x $55 = $2,750
• Remaining 100 units from January 1 = 100 x $50 = $5,000
  Total Ending Inventory = $7,750

Conclusion

The LIFO method is an inventory recording approach beneficial during inflation but has limitations in reflecting the true value of inventory. Selecting an inventory recording method should align with the company’s needs, applicable accounting regulations, and desired financial strategy

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