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Last In, First Out (LIFO)

Last in, First Out (LIFO) is an inventory and cost accounting method used by businesses in the United States to account for their inventory. Under LIFO, the inventory that has been purchased or produced most recently is the first to be expensed. This means that the cost of goods sold on the current financial statement is determined by the most recent purchases or production and not by the cost of the oldest inventories held. By doing this, the balance sheet reflects the current cost of inventory held, while the income statement reflects the current cost of goods sold.

LIFO is governed by the generally accepted accounting principles (GAAP) and is used to lessen the amount of profit which is realised in times of rising prices and help to minimise the amount of taxation for the business. When using the LIFO accounting method, companies usually receive tax advantages, though at the same time, it lowers their net income for the period.

In comparison to other inventory and cost accounting methods, FIFO (first in first out) and the average cost method, LIFO will provide businesses with the greatest tax advantage due to the fact that the most current costs of production are taken into account when calculating taxes. This naturally results in businesses being subject to lower taxation resulting from their net income figures.

For example, if a business was to purchase 1,000 units of a specific item at a cost of $800 as well as 1,000 units of the same item five days later but at a cost of $900, under the LIFO accounting method, 1,000 units of the $900 purchase would be recorded against the cost of goods sold, while the remaining 1,000 units would remain in inventory and the cost of goods sold would be the most recent cost ($900 per item) rather than the oldest inventory (the $800 purchase).

Overall, LIFO is a common inventory and cost accounting method used by companies in the United States to minimise the amount of taxation that payable as well as increasing the total amount of reported assets on a company's balance sheet.

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