LIFO (Last-In, First-Out)

1. Definition

LIFO is an inventory costing method where the last items purchased are assumed to be the first items sold.

2. Analogy

• Stack of Plates: You take the plate from the top, which was the last one added.
• Coal Pile: You shovel coal from the top of the pile.

3. Financial Impact (During Inflation)

When prices are rising, LIFO results in:

1. Higher COGS: The most recent (expensive) costs are matched against revenue.
2. Lower Net Income: Higher costs reduce reported profit.
3. Lower Taxes (Key Benefit): Lower profit means less taxable income. This cash flow benefit is the main reason companies use LIFO.
4. Lower Ending Inventory: The balance sheet shows older, cheaper costs, often undervaluing current assets.

4. Important Note

• Banned under IFRS: Not allowed in most countries (including Korea) because it distorts the balance sheet.
• Allowed under US GAAP: Commonly used by U.S. companies for tax advantages. When analyzing U.S. stocks, check if they use LIFO reserve to adjust for this.