LIFO: what does “Last In, First Out” mean?

With the LIFO process, the last goods added to the stock are the first to be picked. The LIFO principle can also play a role in establishing a company’s financial balance sheet.

What is the LIFO method?¶

The LIFO principle corresponds to an inventory management method according to which the last goods added to the stock are the first to be picked. LIFO is the acronym for the expression “Last In, First Out”, which literally translates as “last in, first out”. Since the LIFO method can also play a role in the valuation and taxation of goods, it is particularly advantageous if you use merchandise management software for your online store, if you want to manage your supply chain in a optimal or if you are looking to provide your company with a comprehensive distribution policy. However, the LIFO method can also be applied automatically in companies that have no storage strategy; as a general rule, however, such use is not recommended.

How does the LIFO method work?

To better illustrate this method, let’s start by using an example of the LIFO principle applied to your daily life. Imagine your tidy closet, and a new T-shirt which is added to the clothes already worn: you fold it neatly before placing it at the very top of the pile, above the other T-shirts. The next day, you take this same item of clothing out of your closet, and the rest of your “stock” remains intact. It is therefore this same LIFO principle that can also be applied to the management of goods. The latest articles are stored in such a way as to be picked up the first. Thus, the LIFO principle is clearly opposed to the FIFO process (“First In, First Out”).

What are the requirements for the application of the LIFO process?¶

Regarding the application of the LIFO process, the nature of the goods stored in the relevant warehouse is truly decisive. It is in fact not recommended to use the LIFO method for products marked with an expiry date, which could be damaged by prolonged storage, which may lose value over time or which meet certain (ephemeral) trends.

However, if the goods you are storing are stable and do not need to be picked in any particular order, the LIFO method is relatively simple to set up. You can store your goods in a warehouse, an open space or a pit, on high shelves or shelves fixed to the wall. With the LIFO method, however, it can be difficult to keep an overview of your stock.

##What are the advantages of the “Last In, First Out” system?

If your warehouse and the nature of your goods meet the conditions specific to the “Last In, First Out” method, be aware that this system offers several advantages. For starters, it’s impressively simple. There is no need to train new staff in the LIFO process; these can work in your warehouse without much previous experience with the method being necessary. It considerably reduces downtime related to the organization. Generally, the LIFO principle also requires less staff to put away and pick up the goods. The journeys required are also shorter. The LIFO method can also allow you to reduce your storage costs by optimizing the available space and by storing older goods for the long term. With the LIFO technique, you don’t necessarily have to invest in expensive, stand-alone shelving systems.

How is stock valued with the LIFO method?

The role of the “Last In, First Out” technique goes far beyond simple inventory management. The LIFO method can indeed be used to evaluate the capital of your company; in France, it is used in practice both in commercial law and in tax law. This technique is particularly recommended in the event of a period of high inflation to take into account the increase in prices.

The LIFO principle in French commercial law¶

In France, the LIFO principle is not expressly mentioned in commercial law. It is, however, often used in practice for inventory management in commercial enterprises. By following the principle of « Last In, First Out », the last goods added are therefore the first to be removed, whether or not you apply this method exactly on a daily basis.

The LIFO principle in French tax law¶

With regard to the LIFO method and the trade balance, French tax law establishes, by virtue of Article 39 of the General Tax Code, the LIFO principle as a valid valuation method of taxable profit. However, companies must also comply with the accounting regulations in force in France. If you want to use this method as a business, however, we recommend that you call on an accountant, because its use must be justified in the event of a tax audit.

What are the different LIFO methods?¶

To perform your calculations according to the « Last In, First Out » principle, two different methods are available to you: on the one hand, the permanent LIFO method, and on the other, the periodic LIFO method. Whichever LIFO method you choose, you shouldrigorously apply the minimum value valuation method. According to this method, assets should never be overstated in a balance sheet; if it is possible to determine lower values, these should be used instead. Thus, at the closing date of the balance sheet, all values ​​are compared with those of the same goods available on the market, and only the lowest value is taken into account.

The permanent LIFO principle¶

With the permanent LIFO method, entries and exits are logged continuously over the entire period. If this LIFO principle is very precise, it also takes a lot of time. For this reason, it is rarely put into practice. Discover with us an example of how the permanent LIFO method works.

To do this, let’s imagine a company that produces confectionery and for this purpose uses sugar. You will find below its breakdown for the last financial year:

The first goods issue took place on May 1. The delivery of February 1 was therefore taken into account according to the LIFO method. However, as this was not sufficient, an additional 10 kg were taken from the starting stock. 100 kg are therefore invoiced at the purchase price of €1, to which are added 10 kg at €2. The total value therefore corresponds to 120 €. The second goods issue drew on the July 1 delivery, for which the price per kilo was €4. However, as the 150 kg delivered were not enough, an additional 50 kg were again taken from the starting stock. This output therefore amounts to a total of 700 €.

As the deliveries have been completely consumed, the remaining sugar comes only from the starting stock. For the final stock, the remaining 140 kg must therefore be multiplied by the starting price of €2 to obtain a total of €280. To calculate the material costs, it remains to add the two goods issues: 120 € + 700 € = 820 €.

The periodic LIFO principle¶

The operation of the periodic LIFO method is somewhat different. With this one, only the ending stock is entered before being multiplied by the starting stock price; this simplifies the calculation. Under the LIFO method, the last stocks to be delivered have normally already left the warehouse. For the example above, the calculation based on the periodic LIFO principle would look like this:

The ending stock is calculated based on the starting stock. In the example above, the 140 kg are therefore again multiplied by 2 €, for a total of 280 €. To calculate the material costs, the following operation should be carried out:

starting stock + goods receipts – ending stock.

This translates as follows: 200 kg x €2 + 100 kg x €1 + 150 kg x €4 – €280 = €820. Now, to calculate the value of the individual issues, divide the remaining stock by the total goods issues. In this example, it would therefore be a question of dividing 820 € by 310 kg, which would give approximately 2.65 €/kg.