LAST-IN, FIRST-OUT (LIFO) is a term used in both accounting and employment policies. It has distinct applications in inventory accounting and workforce management.
Historical Context
Accounting
The LIFO method of accounting for inventories was developed as a means to align the cost of goods sold (COGS) more closely with current market costs. This became particularly popular during times of inflation when newer inventory costs are higher than older inventory.
Employment
In workforce management, LIFO emerged as an objective rule to manage layoffs, aiming to reduce biases and ensure newer employees, typically less experienced, are the first to be laid off during economic downturns.
Types and Categories
Accounting Method
- Inventory Management: Primarily used in inventory-heavy industries like retail, manufacturing, and automotive.
Employment Policy
- Layoff Procedures: Utilized in various sectors, often where unions are strong and standardized rules are preferred.
Key Events
- 1939: The U.S. first allowed LIFO for tax reporting.
- 1970s: LIFO saw widespread adoption during periods of high inflation.
- 1986: The Tax Reform Act allowed companies to use LIFO for tax purposes.
Detailed Explanation
Inventory Accounting Method
The LIFO method assumes that the last items placed in inventory are the first ones sold. This method contrasts with First-In, First-Out (FIFO).
Mathematical Formula:
Example:
Consider a company with the following inventory purchases:
- 100 units at $10
- 100 units at $12
- 100 units at $15
If the company sells 150 units:
- Under LIFO, the COGS will be calculated using the costs of the most recent units (100 units at $15 + 50 units at $12).
Mermaid Diagram for Inventory Flow:
flowchart LR
A[Inventory In] --> B[Most Recent Inventory]
B --> C[Old Inventory]
D[Sales] --> B
Employment Policy
LIFO as an employment policy means that during layoffs, the most recently hired employees are the first to be terminated.
Considerations:
- Reduces subjectivity in layoff decisions.
- Can lead to a loss of new talent and fresh perspectives.
Importance and Applicability
Accounting
- Helps match current costs with current revenues.
- Can reduce taxable income during periods of rising prices.
Employment
- Ensures fairness and consistency in layoff procedures.
- Common in unionized environments.
Examples
Inventory Management
A retail chain with fluctuating inventory prices might use LIFO to better reflect current market prices in their financial statements.
Layoff Policy
A manufacturing plant facing decreased orders may use LIFO to determine layoff sequence to comply with union agreements.
Related Terms with Definitions
- First-In, First-Out (FIFO): An accounting method that assumes the oldest inventory is sold first.
- Weighted Average Cost: An inventory costing method that averages all costs of goods available for sale.
Comparisons
| Aspect | LIFO | FIFO |
|---|---|---|
| Inventory Value | Usually lower during inflation | Usually higher during inflation |
| Tax Implications | Potentially lower taxable income | Potentially higher taxable income |
Interesting Facts
- LIFO can result in significant tax deferrals, especially during inflation.
- Some countries, like the United Kingdom, do not permit the use of LIFO.
Famous Quotes
“Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings.” – Diane Garnick
FAQs
Is LIFO allowed under IFRS?
Why might a company prefer LIFO?
References
- Accounting Standards Codification (ASC) 330
- Tax Reform Act of 1986
Summary
LAST-IN, FIRST-OUT (LIFO) is a significant concept in both accounting and employment contexts. In accounting, it helps manage the cost of goods sold by using the cost of the most recent inventory, while in employment, it provides a standardized method for layoffs. Both uses aim to bring objectivity and fairness to their respective fields.
