This method assumes that inventory purchased last is sold first. Therefore, inventory cost under LIFO method will be the cost of earliest purchases. Consider the following example:
Example
Bike LTD purchased 10 bikes during January and sold 6 bikes, details of which are as follows:
January 1 Purchased 5 bikes @ $50 each
January 5 Sold 2 bikes
January 10 Sold 1 bike
January 15 Purchased 5 bikes @ 70 each
January 25 Sold 3 bikes
The value of 4 bikes held as inventory at the end of January may be calculated as follows:
The sales made on January 5 and 10 were clearly made from purchases on 1st January. However, all sales made on January 25 will be assumed to have been made from the purchases on January 15. Therefore, the value of inventory under LIFO is as follows:
| Date | Purchase | Issues | Closing Inventory | ||||||
|---|---|---|---|---|---|---|---|---|---|
|
|
Units |
$/Units |
Total |
Units |
$/Units |
Total |
Units |
$/Units |
Total |
|
Jan 1 |
5 |
50 |
250 |
- |
- |
- |
5 |
50 |
250 |
|
Jan 5 |
- |
- |
- |
2 |
50 |
100 |
3 |
50 |
150 |
|
Jan 10 |
- |
- |
- |
1 |
50 |
50 |
2 |
50 |
100 |
|
Jan 15 |
5 |
70 |
350 |
- |
- |
- |
5 |
70 |
350 |
|
Jan 15 |
- |
- |
- |
- |
- |
- |
7 |
- |
450 |
|
Jan 25 |
- |
- |
- |
3 |
70 |
210 |
2 |
50 |
100 |
|
|
- |
- |
- |
- |
- |
- |
2 |
70 |
140 |
|
- |
- |
- |
- |
- |
- |
- |
4 |
- |
240 |
As can be seen from above, LIFO method allocates cost on the basis of earliest purchases first and only after inventory from earlier purchases are issued completely is cost from subsequent purchases allocated. Therefore value of inventory using LIFO will be based on outdated prices. This is the reason the use of LIFO method is not allowed for under IAS 2.
Quiz
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Question
Relevance is one of the primary qualitative characteristics of financial information. Which of the following methods of inventory valuation is not consistent with the characteristic?
LIFO Method
Correct.
Under LIFO method, inventory is valued at the earliest purchase cost. As inventory is stated at outdated prices, the relevance of accounting information is reduced because of possible variance with current market price of inventory.
FIFO Method
Incorrect.
Under FIFO method, inventory is valued at the latest purchase cost. As inventory is stated at price which is close to current market value, this should enhance the relevance of accounting information.