LIFO
Karen Koch, CPA, MT
March 4, 2024
LIFO stands for “Last-In, First-Out.” It’s an inventory cost flow assumption and identification method that assumes the most recently purchased items are sold first.
In order to use LIFO, a company must formally elect to do so through filing Form 970 – Application to Use LIFO Inventory Method. Should a company wish to make any changes to the accounting method, they must do so on Form 3115 – Application for Change in Accounting Method. The company is also required to use LIFO for financial reporting purposes, the “LIFO conformity requirement.”
LIFO can potentially reduce income taxes during periods of inflation by lowering reported cost of goods sold (COGS), leading to higher taxable income. It can also simplify record-keeping for certain industries.
Any company affected by inflation and with a substantial inventory may use LIFO. Manufacturers, retailers, and wholesalers all use LIFO. Various industries such as oil & gas, chemical, metal, lumber, hardware, grocery, and building supplies all use LIFO.
When inventory levels fail to increase faster than cumulative inflation, older inventory layers are removed, effectively paying back the LIFO reserve attributable to those layers.
LIFO can lower reported COGS and net income during inflation, potentially decreasing tax liability. Conversely, in deflationary periods, it can artificially inflate COGS and decrease net income.
