How to Calculate LIFO Ending Inventory

The Last-In, First-Out (LIFO) method is an accounting technique businesses use to value inventory and determine the cost of goods sold. This approach helps companies match their most recent costs against current revenues, which can be advantageous during periods of inflation. By assigning the costs of the latest purchased items to the goods sold, LIFO influences a company’s reported profit and tax obligations. LIFO serves as a tool for financial reporting and tax planning, allowing businesses to manage their financial outcomes based on the flow of inventory costs.

LIFO Inventory Fundamentals

The LIFO method assumes the most recently acquired inventory items are sold first. This “Last-In, First-Out” principle means that when a sale occurs, the cost assigned to that sale comes from the newest inventory available. Consequently, the inventory remaining at the end of an accounting period consists of the oldest items purchased. This approach contrasts with other methods, such as First-In, First-Out (FIFO), where the oldest items are sold first.

A core concept in LIFO is the creation of “inventory layers.” Each time a business purchases inventory at a different cost, a new layer is formed. For instance, if a company buys 100 units at $10, then another 50 units at $12, these represent two distinct cost layers. When goods are sold, LIFO dictates that the units from the most recent layer are expensed first, drawing down that layer’s quantity until it is depleted, before moving to the next most recent layer.

The application of LIFO depends on the inventory system a business employs: periodic or perpetual. Under a periodic inventory system, the LIFO assumption is applied only at the end of an accounting period. All purchases and sales throughout the period are tallied, and then the LIFO calculation is performed retrospectively to determine the cost of goods sold and ending inventory. This system does not track inventory continuously.

In contrast, a perpetual inventory system continuously updates inventory records with each purchase and sale. With perpetual LIFO, the “Last-In, First-Out” assumption is applied at the time of each sale transaction. This means that as soon as an item is sold, its cost is immediately removed from the most recent inventory layer. The continuous updating provides real-time inventory balances and cost of goods sold.

For businesses using LIFO in the United States, the LIFO conformity rule is stipulated under Internal Revenue Code Section 472. This rule mandates that if a company uses LIFO for tax purposes, it must also use LIFO for financial reporting purposes to shareholders and creditors. This prevents companies from presenting higher profits to investors using a non-LIFO method while simultaneously reporting lower profits for tax benefits. LIFO is not permitted under International Financial Reporting Standards (IFRS) due to concerns about potential distortions to profitability and outdated inventory valuations.

Gathering Necessary Inventory Information

Before any LIFO ending inventory calculation, specific data points must be collected and organized. Businesses must have a clear record of their inventory at the start of the accounting period. This includes the number of units on hand and their associated cost, which forms the initial inventory layer.

Detailed information about all purchase transactions made during the period is essential. For each purchase, the date of acquisition, the number of units bought, and the cost per unit must be recorded. These purchase records establish the various cost layers that will be used in the LIFO calculation. Organizing these purchases chronologically helps in correctly identifying the “last-in” items.

Finally, the total number of units sold throughout the accounting period is needed. The quantity of units sold determines how many units are assumed to have left inventory. Collecting beginning inventory, purchase details, and total units sold provides the data necessary for applying the LIFO method.

Calculating Ending Inventory Under Periodic LIFO

Calculating ending inventory under the periodic LIFO system involves determining the cost of goods remaining at the end of an accounting period by assuming the most recently purchased items were sold first. This method performs a single calculation at the period’s end. The process begins by identifying the total number of units sold during the period and subtracting this from the total units available for sale. The remaining units represent the ending inventory.

To assign a cost to these remaining units, one must work backward through the inventory layers, starting with the earliest purchases. For example, consider a company with a beginning inventory of 100 units at $10 each. During the period, it made two purchases: 150 units at $12 each and 200 units at $13 each. The total units available for sale are 100 + 150 + 200 = 450 units. If the company sold 300 units during the period, its ending inventory would be 450 – 300 = 150 units.

Under periodic LIFO, the 300 units sold are assumed to come from the latest purchases. This means 200 units would come from the $13 layer, and the remaining 100 units would come from the $12 layer. Therefore, the units remaining in ending inventory would be the 100 units from beginning inventory at $10 each and 50 units from the first purchase at $12 each.

The calculation of ending inventory would be: (100 units $10/unit) + (50 units $12/unit) = $1,000 + $600 = $1,600. This $1,600 represents the cost of the 150 units in ending inventory.

Calculating Ending Inventory Under Perpetual LIFO

Calculating ending inventory under the perpetual LIFO system requires continuously updating inventory records and applying the LIFO assumption with each sale transaction. As new purchases arrive, they form new cost layers, and as sales occur, the units are assumed to be drawn from the most recent layers.

To illustrate, consider a company with a beginning inventory of 50 units at $10 each. On January 5, it purchases 100 units at $12 each. On January 10, it sells 80 units. Under perpetual LIFO, these 80 units sold are assumed to come first from the most recent layer (the 100 units at $12). Therefore, 80 units at $12 each are expensed as cost of goods sold, leaving 20 units at $12 in that layer and the original 50 units at $10.

Next, on January 15, the company purchases another 120 units at $13 each. This creates a new layer. Then, on January 20, it sells 100 units. These 100 units are assumed to come first from the newest layer (the 120 units at $13). So, 100 units at $13 each are expensed, leaving 20 units at $13 in that layer. The remaining inventory consists of 50 units at $10, 20 units at $12, and 20 units at $13.

The ending inventory would be calculated as: (50 units $10/unit) + (20 units $12/unit) + (20 units $13/unit) = $500 + $240 + $260 = $1,000. This $1,000 represents the cost of the 90 units in ending inventory.