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Accounting terms explained in a simple way

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LIFO – What is LIFO?

Definition: LIFO is a method of stock valuation that stands for ‘Last-In, First-Out’. This assumes that the units of stock (newest) which were most recently produced or received are the items to be recorded as sold first.

Last in, Last out

Under the LIFO method of stock valuation, a company assumes that the newest units in stock are the ones being sold first – regardless of which units are actually sold first. This way, if the price of production or the wholesale purchase cost of these items was different than the current price, then you will account for these goods as the most recent value – not the previous one.

LIFO is the opposite of the FIFO valuation method, which conversely assumes that the oldest recorded cost of units in stock should be recorded as being sold first.

Stock valuation

The LIFO and FIFO Methods are accounting techniques used in managing a company’s stock and financial matters. They help a company determine the value of their stock, raw materials, etc. They are used to manage cost flows assumptions related to stock and stock repurchases (if purchased at different prices).

LIFO vs. FIFO example

To show the difference between LIFO and FIFO, let’s use the example of a company that produces widgets. Let’s say that this company produces 500 widgets on Monday at a cost of £1.00 each, and 500 more on Tuesday at £1.25 each. Now they have 1,000 widgets in stock worth £1,125.00.

LIFO states that if the company then sold 500 widgets on Wednesday, their cost of goods sold for those 500 widgets is £1.25 per widget, or $625.00 (recorded on the income statement). That’s because £1.25 was the cost of each of the last widgets in their stock. The remaining 500 widgets would then be allocated to the company’s ending stock at £1.00 each (recorded on the balance sheet), resulting in an ending stock balance of £500.00.

LIFO banned by the IFRS

Around the 1970s, companies in the United States began shifting towards the use of LIFO, since valuating their stock this way reduced their income taxes during times of inflation.

The International Financial Reporting Standards (the IFRS) soon banned the use of LIFO however, which has resulted in many US companies returning to FIFO.

LIFO is only used in Japan and the U.S. It is not applicable in the United Kingdom, where stock valuation is typically recorded by either the average cost or FIFO valuation method.