The LIFO valuation method, along with the method FIFO, is an accounting method widely used to know the present value of inventories and other financial matters that are related in a company with inventory of goods produced, materials for production and all kinds of components or elements that are necessary for the herself.
In this article you will find:
Where does the term LIFO come from?
They are the acronym in English last in, first out or in Spanish last to enter first to leave and according to this concept the merchandise or products that are sold first are the last to be replaced or to be bought again. This is done in order to provide a balance to match actual expenses and income.
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LIFO in computing
It is widely used when structuring data in an efficient way and in queuing theories and in an analog way it could be seen as a pile of objects, in which these objects are stacked one on top of the other and at the moment of removing one, the object that has been put out of latest. This is very important for the efficiency of multiple systems and so that they can work faster without crashing.
LIFO in maritime terms
In maritime transport or trade this term means Liner in free out, which means according to the contract who will pay for the placing on board and unloading at the place of origin of the merchandise or products transported.
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What is the LIFO settlement?
It is a situation in which the company does not seek to replace the inventory or increase its profit, that is, it only seeks to liquidate the old inventory. Sometimes some companies have inventories that are even decades old and liquidating it could result in a inflated billing that would lead to higher tax payments and eliminate the advantage initially given by this method.
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Weighted average price and how it relates to LIFO
Also known as PMP, it is a method that must also be considered and that is related to revaluation of existence, this is because in this method the full cost of producing or acquiring a good is taken and then sell it. It is related to the LIFO method because the way in which these products enter and leave does not have a specific relevance here either.
In the LIFO method the most recent reservations in the inventory are counted, this can give you more knowledge exact value of what you sell with respect to the market price, this method is widely used in periods of inflation.
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Advantages and disadvantages of the LIFO method
Its main advantage as we mentioned is to have an idea more adjusted to the reality of the company, it shows the products that came out with less notice, although on the other hand, making a mistake and evaluating it has led to it being banned in countries such as Spain.
It is worth noting that when choosing the system or LIFO method, you will not be able to start using or rather to switch to the FIFO method in several years according to, this according to the IRS, when selling a higher amount of inventory causing a wide difference between current market prices and the base cost of inventory initial.
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How to apply LIFO to your company
It begins with an inventory list made in a certain period of time, for this first parameter take into account the date on which the purchase was made. As an example we can mention a company that in June acquired 300 devices at a price of 3 euros each, then in July it acquired 1000 cases for mobile phones for a price of 2.5 euros each and then 500 more in August at a price of 4.5 euros per unit, of which 1,200 of these are sold in the month of September.
To calculate the LIFO cost, you must assume that those products, accessories, devices purchased in September were the first to come out, that is (last in, first out) is say that here are the 500 acquired in August and the 700 that you acquired in July, that is (500 x US $ 4.50) + (700 x US $ 2.50) which would yield an average cost of 3.33 euros.
Tips
These methodologies, both LIFO and FIFO, which could be defined as 2 sides of the same coin reflect the related flow with costs, that is, you must bear in mind that it is not related to the costs of physical existence that may exist in the business.
It is common for most companies to try not to accumulate waste, selling the old first since they run the risk that their products may become obsolete after a period of time.
Both LIFO and FIFO have different implications at the time of income and in the declarations that have to do with the flow of money and as we have already mentioned in inflationary systems LIFO will result in higher prices for the best selling units.
Differences between FIFO and LIFO
The main difference is given in its own acronyms since FIFO means First in, Firsts out, it is say first in and first out, while LIFO is last in, first out, last in first leave.
The FIFO system or method is widely used in perishable products, here those that are closest to their expiration date must come out first. It is very convenient to increase assets in times of inflation and over time in order to reduce taxes They change to the LIFO method, this is something common in companies, to use one method in the beginning and then change to the others.
The LIFO method, unlike FIFO, is used in case of products that do not expire for this reason, it is ideal in the case of storing products, as we mentioned before, this inventory will have a lower cost while the prices go up.
The strongest point of this method is the direct relationship between the expenses incurred now and the current income, that is say to summarize we can conclude that what this method pursues is the first sale or sale of those products more expensive.
