In this video you'll find out what LIFO means…
Last In First Out now let's see how it works.
[Music]
Hey there, I'm James
you're watching Accounting Stuff and today we're going to talk
Inventory Cost Flow Assumptions.
There are three of these…
FIFO, LIFO and AVCO.
In my last video I explained why we need them and we talked
a bit about FIFO.
If you missed it have no fear you can find the link up here
[Laughs]
and down in the description
along with the rest of the inventory playlist.
Today we're moving on I'm going to show you a four step process
to calculate your cost of goods sold and closing inventory using LIFO
and next time we'll round things off with a video about AVCO
so if you'd like to see that remember to click subscribe
oh yeah…
First, a quick reminder… the basic inventory calculation looks like this.
You have your opening inventory plus your additions
which gives you your cost of goods available for sale
and when you take away your cost of goods sold you get
your closing inventory.
When we talk Inventory Cost Flow Assumptions
we're trying to work out how much cost needs to flow in to
cost of goods sold in your income statement when you make a sale
and on the flip side how much cost should remain where it is
in your closing inventory in your balance sheet.
Calculating this can be a bit tricky if you pay different amounts
for your inventory to begin with and that's where Inventory Cost
Flow Assumptions come in.
These are some basic rules that help you estimate your cost flows.
They don't reflect the reality of underlying transactions.
There are three Cost Flow Assumptions…
FIFO, LIFO and AVCO First In First Out
Last In First Out and the Average Cost Method.
In this video we're going to cover LIFO.
When you make a sale using the LIFO method
you make the assumption that your newest inventory will be sold first.
Last to come in first to go out.
Time for an example we're going to use the same one that
we did in the FIFO video which means…
Squeegees!
It’s the start of November and you have 220 squeegees in your inventory.
These cost you two dollars each.
On November 5th you buy another 400 squeegees for $1,200
and a few days later on November 12th you sell 500 squeegees for $2,750.
What's your cost of goods sold and closing inventory for November
assuming that you’re using the LIFO Cost Flow Assumption?
Last In First Out.
It's time for some steps.
We'll go through them now but you can also get them on my Inventory
Cost Flow Assumptions cheat sheet.
If you're finding these accounting tutorials at all helpful
and you'd like to help support the channel then the best way
you can do that is by buying one of my cheat sheets.
You can find the link up here and down below as usual.
Step 1 Draw an Inventory Cost Flow Table.
This is a table made up of five columns…
Date, description, quantity cost per unit and total cost.
Step 2 Enter what you know.
What do we know?
We know that you began November with 220 squeegees which cost you $2 per unit.
So at the start of November you had an opening inventory of 220 units
which cost you $2 each.
On November 5th you went and bought another 400 squeegees costing
you $1,200 in total.
This belongs in the table as well.
On November 5th you added 400 units to your inventory
which came to $1,200.
In inventory cost flow tables you want to leave blank rows beneath
each addition or sale.
This gives you some room to put your goods available for sale
which is a subtotal of the rows directly above it.
On November 12th you sold 500 squeegees for $2,750.
Now be careful here this $2,750 is the revenue that you’ve earned
not the cost of goods sold that you've incurred
so it doesn't belong in the inventory cost flow table.
So on November 12th you sold 500 units and that's all we know about this transaction.
We'll need to work out your total cost of goods sold later.
We're also going to calculate your closing inventory on November 30th.
Right, Step 3.
We need to fill in the blanks.
We'll begin by calculating the total cost of your opening inventory.
You kicked off the month with 220 units which cost you $2 per unit.
220 multiplied by $2 is $440.
Next we'll work out the cost per unit of your additions.
You bought 400 units which cost you $1,200 in total.
$1,200 divided by 400 units is $3 per unit.
Now we can take some subtotals to work out your goods available for sale.
220 plus 400 is 620 units available for sale and 440 plus 1200 is $1640
your total cost of goods available for sale.
When using the LIFO or FIFO methods you can ignore the cost per unit
of your goods available for sale goods sold and closing inventory
so we can move on and calculate your total cost of goods sold.
You sold 500 units but what was the cost of goods sold
that you incurred in this transaction?
Remember LIFO means Last In First Out.
The last squeegees you bought were your additions of 400 units
which cost you $3 per unit but you still need to sell another
100 units to reach 500.
The next hundred units come from your opening inventory
which cost you $2 per unit.
So let's work this out…
400 units multiplied by $3 is $1200 and 100 units multiplied by $2 is $200.
1200 plus 200 is $1400 this is your total cost of goods sold.
Great that's the tough bit out of the way now let's find out your closing
inventory on November 30th.
To do that we need to take some totals…
620 minus 500 gives you 120 units and 1640 minus 1400 gives you $240.
Alright, Step 4.
Calculate your total cost of goods sold and your closing inventory.
Your total cost of goods sold for the month can be calculated by adding up
your cost of goods sold for every sell that you've made.
In this example you only made one sale so your total cost of goods sold
for November is $1,400 and the total cost of your
closing inventory is $240.
BOOM!
You can use these same four steps to solve any inventory cost problem.
Now let's have another look at the inventory calculation.
Why would you choose LIFO over the other inventory
cost flow assumptions?
This method allows you to match your current revenues
against your most recent cost of goods.
So your gross profit reflects your business's current performance.
However when prices are rising during times of inflation
your most recent cost of goods are also your highest which
gives you a higher cost of goods sold.
Remember those squeegees in the example went from costing $2 per unit to $3 per unit?
This gives you a lower gross profit so when we compare your results
using LIFO against the FIFO and AVCO methods your gross profit under LIFO
comes in the lowest.
But as a business owner this can be a good thing.
Businesses are charged tax on their profits so lower profits means lower taxes
which can free up more cash for you to use in other areas of your business
at least in the short term.
But be careful…
Last In First Out is not allowed under IFRS.
So if you follow International Financial Reporting Standards
then you'll need to use First In First Out or the
Average Cost method instead.
Next time we'll cover the Average Cost method.
Remember to click subscribe if you'd like to see that.
I made a FIFO video last week as well so if you missed it it's in this playlist
over here and if you're interested in buying
the cheat sheet you can find that over here as well.
It's been a pleasure as always.
See you next time!