Last In First Out LIFO Inventory Method Explained 60 600

Hello, and welcome to this lecture on the Last In First Out (LIFO) inventory method. In this discussion, we’ll explore how LIFO impacts inventory accounting, using the example of selling coffee mugs. Instead of individually tracking each coffee mug, we’ll employ the cost flow method, specifically LIFO, to manage our inventory. To facilitate this process, we recommend setting up a worksheet with three essential components: purchases, merchandise cost, and ending inventory. This approach allows us to calculate units sold, unit costs, and total costs, addressing various questions that may arise.

Why do we need a worksheet? Well, the trial balance reports inventory in dollars, while inventory management often involves units and unit costs. Cost flow assumptions help bridge this gap.

Let’s start with our initial inventory: 100 units at a cost of $50 each, totaling $5,000. This figure matches our trial balance. Next, we make a purchase of 400 units at $55 each, increasing our inventory to 500 units and our total inventory cost to $27,000. This purchase is recorded as a straightforward journal entry – debit to inventory and credit to accounts payable.

Now, we need to update our worksheet. We currently have 100 units at $50 and 400 units at $55, creating two layers. Everything under the red line represents the latest transaction. To reflect this, we move the 100 units at $50 down and add the $55 units for a total of 500 units at $55, totaling $27,000 – again matching our trial balance.

Now comes the question: When we make a sale, do we sell the older units at $50 each, or the newer ones at $55 each? Under LIFO, we assume we sell the newer units. However, this is just an inventory assumption, and we can make different assumptions if we don’t know which units were actually sold.

Let’s consider a sales transaction where we sell 420 units at $85 each. This leaves us with 80 units in inventory. The sales journal entry focuses on the sales price and is straightforward: we debit accounts receivable and credit revenue for the total sales amount, which is 420 units multiplied by $85.

Now, we need to determine the cost of goods sold (COGS). To do this, we turn to our worksheet. Using LIFO, we sell the newer units first. So, we account for the entire 400 units at $55 each, which totals $22,000. This accounts for part of the 420 units sold. To calculate the remainder, we look at the older units: 80 units at $50 each, totaling $4,000. In total, our COGS is $22,000 + $4,000, which equals $26,000.

After this journal entry, our inventory will be reduced by $26,000, leaving us with $4,000 – matching the inventory amount on our trial balance.

In summary, the LIFO inventory method assumes that newer units are sold first. By using a worksheet, we can accurately calculate the cost of goods sold and ensure that our inventory balances match the amounts on the trial balance. This method helps us make informed decisions about inventory management and financial reporting.


Leave a Reply

Your email address will not be published. Required fields are marked *