How to Calculate LIFO and FIFO: Accounting Methods for Determining COGS Cost of Goods Sold

Last In First Out method is one of the three cost assignment methods used to value period end inventory still at hand and cost of goods sold during the period. Computers for your store were purchased each month from May through August. However, the cost varied because of the manufacturer’s price reductions.

Even if you’re using a spreadsheet, adding new layers and modifying existing layers takes a lot of data entry and cleaning up. This is the reason why some prefer the periodic inventory system because lifo periodic inventory method of its simplicity. Assume our physical inventory count reveals 80 units in ending inventory. LIFO is an assumption about cost flow that doesn’t have to match the actual physical flow of goods.

What Is a Perpetual Inventory System?

The costs of buying lamps for his inventory went up dramatically during the fall, as demonstrated under ‘price paid’ per lamp in November and December. So, Lee decides to use the LIFO method, which means he will use the price it cost him to buy lamps in December.

The first costs are now in cost of goods sold while the most recent costs remain in the asset account. With FIFO perpetual inventory, the accounting assumes that the oldest inventory has been sold first. That means the cost of goods sold and available for sale are based on the oldest valuation of a product. All inventory you own is scanned using a barcode scanner app for inventory and added to your perpetual inventory system’s database. Once a product or bottle is sold, the transaction is added to the POS system. This data is automatically shared with the perpetual inventory system and inventory levels are updated.

Step 3: Compute the COGS

It stands for “First-In, First-Out” and is used for cost flow assumption purposes. Cost flow assumptions refers to the method of moving the cost of a company’s product out of its inventory to its cost of goods sold. The accounting entries to record a LIFO purchase are to debit inventory and credit cash or accounts payable. For example, if a computer retailer buys 20 desktops for $500 each, it debits inventory and credits accounts payable by 20 multiplied by $500, or $10,000 each. If the retailer buys an additional 10 desktops at $550 each a few days later, it debits inventory and credits accounts payable by 10 multiplied by $550, or $5,500 each. The LIFO method assumes that the first sale will come from the $550 desktops.

Perpetual inventory systems offer real-time insight into your stock levels so COGS is recorded after each sale. Periodic inventory systems are only updated on a set schedule, so the COGS cannot be recorded until the period has ended. While a perpetual system requires comprehensive information about each sale and purchase, periodic systems don’t need to monitor each transaction. Periodic inventory systems are very simple in the world of ecommerce bookkeeping and can compute the cost of goods sold and available for small inventories using a few data points.

Perpetual Inventory

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• Companies also select a cost flow assumption to specify the cost that is transferred from inventory to cost of goods sold (and, hence, the cost that remains in the inventory T-account).
• However, the cost of ending inventory presented in the balance sheet presents older costs.
• As indicated by the name itself, the LIFO method bases the COGS on the cost of the most recent purchases .
• You can use this in the interim period, the time between physical counts, or to estimate how much stock you lost in the case of a catastrophic event.
• The LIFO — last-in, first-out — method assumes that the most recent item into inventory is the first one sold.
• Since only 100 items cost them $50.00, the remaining 5 will have to use the higher $55.00 cost number in order to achieve an accurate total.
• This way, the accounting records show accurate balances in the accounts affected.

Under last-in, first-out method, the costs are charged against revenues in reverse chronological order i.e., the last costs incurred are first costs expensed. In other words, it assumes that the merchandise sold to customers or materials issued to factory has come from the most recent purchases.

How the LIFO Inventory Method Works

Afterward, let’s extend and foot the totals in the last two columns. As of January 15, we still have 30 units from beginning inventory and 30 units from the January 5 purchase. Preparing a schedule of LIFO layers before updating perpetual records for a sale is important in making sure you take COGS from the most recent layer. Take note that you have to repeat this step before you make entries to LIFO layers. This schedule will serve as your guide to what layer needs to be updated.

Six combinations of inventory systems can result from these two decisions. With any periodic system, the cost flow assumption is only used to determine the cost of ending inventory so that cost of goods sold can be calculated. For perpetual, the reclassification of costs is performed each time that a sale is made based on the cost flow assumption that was selected. Periodic FIFO and perpetual FIFO systems arrive at the same reported balances because the earliest cost is always the first to be transferred regardless of the method being applied.

Weighted average cost in a periodic system is another cost flow assumption and uses an average to assign the ending inventory value. Using WAC assumes you value the inventory in stock somewhere between the oldest and newest products purchased or manufactured.