Exploring the Last in First Out (LIFO) Method for Material Pricing

Prices rarely stay the same for long. A company that buys the same raw material in January, March, and June at three different rates faces a genuine accounting question: which of these prices should be charged when the material actually leaves the store for production? The Last in First out (LIFO) method answers this by assuming the most recently purchased stock is used first. It sounds like a small technical choice, but it can quietly reshape a company’s reported profit, its tax bill, and the value of inventory sitting on its balance sheet.

What the LIFO method actually assumes 🔗

LIFO works on a simple logic: the last batch of material to enter the store is the first one to leave it. So if a factory receives materials in three lots – January, March, and June – and needs to issue stock in July, LIFO assumes the June lot is used first, then March, and finally January, only if the earlier stock is needed to complete the issue quantity.

This is purely an accounting assumption about cost flow, not a claim about which physical units are picked off the shelf. A warehouse might still follow a first-in-first-out physical movement for perishable or bulky items, while its books value those issues on a LIFO basis. The two are independent of each other.

A simple worked example 🔗

Assume a stores ledger shows the following receipts of a raw material:

On the 25th, 300 units are issued to production. Under LIFO, the issue is priced starting from the most recent lot:

• 200 units from the 20th lot @ ₹14 = ₹2,800
• 100 units from the 10th lot @ ₹12 = ₹1,200

The total cost of the issue works out to ₹4,000. What remains in stock is 100 units from the opening balance at ₹10 and 50 units from the 10th lot at ₹12 – a closing value of ₹1,600 for 150 units. Notice that the oldest, cheapest lot of ₹10 is the one left untouched in the store, exactly the outcome LIFO is designed to produce.

Why LIFO becomes attractive when prices are rising 🔗

The real appeal of LIFO shows up during inflation. Because the most recent, and usually the most expensive, purchases are charged to production first, the cost of goods sold (COGS) reflects current market prices rather than outdated ones. This is often called better matching of costs with revenue, since a sale made today is measured against what the material would cost to replace today, not what it cost months ago.

Higher COGS during inflation means lower reported gross profit, which in turn reduces taxable income. This is precisely why LIFO has historically been popular with businesses in economies that permit it, particularly in the United States, where it is allowed under Generally Accepted Accounting Principles. A company using LIFO in an inflationary environment reports a cost of goods sold that stays close to current replacement cost, giving management and analysts a more realistic view of the actual cost of running operations right now, rather than a profit figure inflated by cheap, old inventory.

The matching principle in action 🔗

Accountants often describe this as excellent income-statement matching. According to the Corporate Finance Institute, LIFO matches the most recent purchase costs against current revenue on the income statement, which is the strongest argument in its favour. The flip side is that this benefit comes at the cost of an outdated balance sheet, which is exactly what makes LIFO controversial.

The limitations that come with LIFO 🔗

LIFO’s strength on the income statement becomes its weakness on the balance sheet. Because the oldest, cheapest lots are the ones left in stock, the closing inventory value shown in the books can lag far behind current replacement prices, especially if a company holds inventory for several years. A material bought at ₹10 five years ago might still sit on the books at ₹10 even though its market price today is ₹40. This understates the working capital tied up in inventory and can mislead anyone comparing the company’s financial position to a competitor using a different method.

Higher clerical and record-keeping burden 🔗

Maintaining LIFO also demands more disciplined record-keeping. Every lot of material has to be tracked separately by date and rate, and the store ledger has to be updated continuously as new lots arrive and old ones are partly or fully consumed. In businesses with frequent purchases and fluctuating prices, this can get complicated quickly, increasing both the effort and the chance of clerical errors compared to simpler methods like weighted average pricing.

LIFO liquidation risk 🔗

There is also a subtler problem. If a business sells or issues more material than it purchases in a period, it starts dipping into older, lower-cost layers of inventory. This event, known as LIFO liquidation, suddenly pulls old, cheap costs into the current period’s cost of goods sold, artificially inflating profit and creating an unexpected tax liability in that year – the opposite of what LIFO is normally used to achieve.

Is LIFO allowed in India? 🔗

This is where the method runs into a hard wall for most Indian businesses. LIFO is not permitted for external financial reporting in India. Under Ind AS 2, the accounting standard governing inventories, companies can only use the first-in-first-out method or the weighted average cost formula for valuing interchangeable inventory. The same restriction exists internationally: the official text of IAS 2 permits only the FIFO or weighted average cost formula for assigning cost to inventories, with no mention of LIFO as an allowed option.

The reasoning behind this global prohibition is that LIFO can produce inventory values on the balance sheet that no longer reflect current costs, undermining the reliability of financial statements. A comparison of global accounting frameworks by Deloitte’s accounting research platform confirms that while FIFO and weighted average cost are acceptable under IFRS, LIFO remains a method exclusive to US GAAP.

For Indian B.Com and cost accounting students, this creates an interesting situation: LIFO is still taught as part of the theoretical framework of material pricing because it illustrates an important trade-off between income-statement accuracy and balance-sheet accuracy. It also remains directly relevant for understanding how US multinational companies report their inventories, or for comparing financial statements across countries that follow different accounting frameworks.

LIFO compared with other methods 🔗

This table captures why the choice of pricing method is never purely academic – it changes reported profit, tax outgo, and how healthy a company’s balance sheet appears to a lender or investor, even though the underlying business activity is identical.

Why this concept still matters for accounting students 🔗

Even where LIFO cannot be used for statutory reporting, understanding it sharpens a student’s grasp of two ideas that run through all of cost and financial accounting: the trade-off between matching current costs to current revenue, and the trade-off between an accurate income statement and an accurate balance sheet. Exam questions on material pricing frequently ask students to prepare stores ledger accounts under LIFO alongside FIFO and weighted average, precisely to test whether they understand how the same set of purchases and issues can produce three different profit figures.

What do you think? If a company’s reported profit can change simply by switching its material pricing method, how much should investors rely on profit figures alone when comparing two businesses? And in a country where LIFO is banned for reporting, is there still real value in learning it, beyond passing an exam?

References

1. https://kpmg.com/us/en/articles/2026/inventory-accounting-ifrs-accounting-standards-vs-us-gaap.html
2. https://corporatefinanceinstitute.com/resources/accounting/last-in-first-out-lifo/
3. https://cleartax.in/s/indian-accounting-standards-ind-as-inventories-2
4. https://www.ifrs.org/content/dam/ifrs/publications/pdf-standards/english/2021/issued/part-a/ias-2-inventories.pdf
5. https://dart.deloitte.com/USDART/home/publications/deloitte/additional-deloitte-guidance/roadmap-ifrs-us-gaap-comparison/chapter-1-assets/1-4-inventories