The belief in LIFO costing method is based on the assumption that material issued to manufacturing department should carry the cost of most recent purchase, although the physical flow of material inventory may actually be different. It assumes that the most recent costs are significant to match with recent revenues in the profit / loss determination procedures.

Under LIFO method of inventory valuation the most recent costs are charged to cost of production and oldest costs are left in the inventory. In LIFO costing several different alternatives can be applied and each alternative results in different costs for materials issued and the ending inventory which ultimately results in varying profit figures.

Example

Given below is the order of material movement in and from the storeroom of a firm. Determine the material inventory cost in the material card using LIFO method.

Solution

The fundamental difference between the different applications of LIFO method is the time interval between the inventory computations. In the above example of LIFO costing after each receipt and issue a new balance of inventory is calculated along with its value, with the ending inventory consisting of 1000 units having value of $7,800. if a physical instead of perpetual costing procedure is used, whereby the issues are not determined on day to day basis rather are fixed at the end of the period through adding receipts in opening balance and than subtracting the ending inventory from resulting figure, the ending inventory would consist of:

800 units @ $6 (opening inventory)………………………….. $4,800
200 units @ $ 7(oldest purchase)…………………………….. $1,400
1000 units (LIFO inventory at the end of period)…………..  $6,200

Even in the circumstances when cost of materials used and ending inventory figures are different, both procedures are appropriate applications of the LIFO method.

Advantages of LIFO Costing

Following advantages are associated with LIFO costing method:[adsense1]

• The rationale of charging most recent costs to the current period production and be compared to the current period revenues results in a systematic and realistic pricing of material consumed.