LIFO stands for Last-in, First-out cost flow assumption. This means the newest purchase prices are the ones we assign to COGS. In other words, the current inventory is assigned the oldest costs. A physical cost flow example of this assumption could be gravel at the landscaping yard. A truck comes in and dumps a load of gravel in an enclosure. Later, another truck comes and dumps more gravel on top of the first load.

A customer backs in and takes a quarter ton, but hardly scrapes the surface of the newest dumped rock. Another supply truck adds to the pile, and the next customer takes gravel from the front of the pile. The oldest gravel may sit there for years and years unless the company liquidates all the LIFO layers, clear back to the first one.

Again, the cost flow assumption doesn’t have to match the physical flow of goods. A grocery store could use LIFO to account for milk inventories, even though it would never sell the newest milk first, leaving the old stuff to sit and sour in the back. LIFO is just another method of assigning costs to items that we don’t track via specific identification.

Same data as before—the list of sales, by date:

And the purchases:

We’ll use the same worksheet format as before and do our calculations step by step, tracking purchases, COGS, and inventory on hand for each date something happens. This time we’ll use the LIFO method of assigning costs to inventory.

Again, light green represents 10 units of inventory we purchased in mid-October. In late October, we sold six of those units, so we had four left. In mid-November, we bought 25 more baseball bats at a higher price. At that point, we had two LIFO layers: four old October bats at $10 each and 25 new November bats at $12 each. Here’s where LIFO starts to look different from FIFO and the other assumptions.

On Nov 20, NewCo sold six more bats. Under LIFO, we’ll pull the newest costs first: all six bats we sold come from the November 15 purchase.

That leaves us with those four old bats and 19 of the 25 we just bought—on paper only. Remember this is just a theoretical cost flow assumption, not a reflection of the physical flow.

We add another LIFO layer on December 15 when we buy another eight bats at $15 each. Under LIFO, these will be the first costs out the door when the holiday rush hits.

On the 24th, we sell 19 bats:

The assumption is that the most recent purchases are the first to go out, like the gravel pit, regardless of which bats actually sold. We don’t bother color coding them because we don’t get significantly better information using that system.

For the 19 bats we sold, we assume they were the eight we just bought plus 11 out of the ones we bought right before that. At the end of the day, we still have those first four left in inventory and eight of the second batch of bats. A hundred years from now, if NewCo is still in business and because of inflation bats now cost us $130 each, we may have four bats in inventory that have a cost assigned to them of $10. That’s a strange thing about LIFO, and one of the reasons International Financial Reporting Standards (IFRS) doesn’t allow it, even though Generally Accepted Accounting Principles (GAAP) does.

Here’s the completed worksheet for LIFO (which could be called “first-in, still-here, or FISH, but it isn’t).

And the gross profit calculation:

Next, we’ll compare all these different methods to see what kind of impact each one has on the business bottom line.