Last In, First Out Accounting

Last-in, first-out (LIFO) is a method for estimating the value of a company’s inventory against the value of goods sold in a given year. A taxpayer’s gross profit from the sale of goods is determined by subtracting the cost of goods sold from gross receipts. Cost of goods sold generally is determined by adding the taxpayer’s inventory at the beginning of the year to the purchases made during the year and then subtracting the taxpayer’s inventory at the end of the year. The LIFO method assumes the items in ending inventory are those earliest acquired by the taxpayer. This runs counter to international accounting practices that typically employ the first-in, first-out (“FIFO”) method, which assumes the items in ending inventory are those most recently acquired by the taxpayer (i.e. the older goods are sold first). LIFO allows companies to decrease the value of their ending inventories artificially for tax purposes in order to increase their reported cost of goods sold, which decreases their taxable income.