---
title: "LIFO Method: Definition, Formula & Examples"
description: "Understand the LIFO method of inventory valuation, its formula, advantages, disadvantages, and real-world examples in accounting business."
canonical: "https://busy.in/inventory-guide/what-is-the-lifo-method/"
author: "Shivani Kandalkar"
published: "2025-08-27T18:30:00.000Z"
category: "Inventory Guide"
---

-   LIFO, or Last-In, First-Out, is an inventory valuation method where the latest purchase costs are assigned to Cost of Goods Sold first.
-   It can reduce reported profit during inflation because newer, higher costs are charged to COGS first.
-   LIFO is allowed under US GAAP, but it is not allowed under IFRS or Ind AS.
-   IAS 2 and Ind AS 2 allow FIFO or Weighted Average Cost for ordinarily interchangeable inventory, not LIFO.
-   For Indian businesses, LIFO should be understood for accounting knowledge and financial statement analysis, but not used for inventory valuation in regular accounting or tax computation.

# LIFO Method: Meaning, Formula, Examples, and India Applicability

## **What is the LIFO Method?**

The LIFO method, or Last-In, First-Out method, is an inventory valuation method where the most recent inventory costs are treated as sold first. This does not always mean the newest physical stock is actually sold first. In most cases, LIFO is an [**accounting assumption**](https://busy.in/accounting/fundamental-accounting-assumptions-types-and-parameters/) used to determine which inventory costs are recognized in Cost of Goods Sold. For example, if a business buys the same item at ₹50 and later at ₹60, LIFO assumes the ₹60 cost is used first when goods are sold. LIFO is often discussed in countries where it is permitted for tax and financial reporting purposes. In simple terms:

-   The latest purchase cost goes to COGS first
-   Older [**purchase cost**](https://busy.in/accounting/what-is-bookkeeping-benefits-principles-and-the-process/) stays in the closing inventory
-   During inflation, COGS becomes higher
-   [**Profit becomes lower**](https://busy.in/accounting/profit-and-loss-appropriation-account/)
-   Closing inventory may show older costs

## **How the LIFO Method Works in Accounting**

Under LIFO, the cost of goods sold is calculated by starting from the latest purchase batch and moving backwards. This increases COGS when prices are rising. For example, a shop buys:

| Purchase Batch | Units | Cost per Unit |
| --- | --- | --- |
| Older batch | 100 | ₹50 |
| Newer batch | 100 | ₹60 |

If the shop sells 120 units, LIFO will first use the newer ₹60 batch and then use the older ₹50 batch for the remaining units.

#### **Formula for Calculating LIFO Inventory and COGS**

There is no single fixed formula for every LIFO case because inventory is calculated layer by layer. A practical formula is:

**LIFO COGS = Cost of latest inventory layer used + cost of next latest inventory layer used + cost of older layers used, until total sold quantity is covered**

**Ending Inventory = Total cost of goods available for sale - LIFO COGS**

For example, a business purchases:

| Batch | Units | Cost per Unit | Total Cost |
| --- | --- | --- | --- |
| Batch 1 | 100 | ₹50 | ₹5,000 |
| Batch 2 | 100 | ₹60 | ₹6,000 |
| Total | 200 |  | ₹11,000 |

If the business sells 120 units, then under LIFO:

| Layer Used | Units | Cost per Unit | COGS |
| --- | --- | --- | --- |
| Newer batch | 100 | ₹60 | ₹6,000 |
| Older batch | 20 | ₹50 | ₹1,000 |
| Total COGS | 120 |  | ₹7,000 |

Ending Inventory: 80 units from older batch × ₹50 = ₹4,000

**FIFO Comparison:** Under FIFO, the older batch is used first:

| Layer Used | Units | Cost per Unit | COGS |
| --- | --- | --- | --- |
| Older batch | 100 | ₹50 | ₹5,000 |
| Newer batch | 20 | ₹60 | ₹1,200 |
| Total COGS | 120 |  | ₹6,200 |

Ending Inventory under FIFO: 80 units × ₹60 = ₹4,800

So in this example, LIFO gives higher COGS and lower [**closing inventory**](https://busy.in/accounting/inventory-accounting/) when prices are rising.

| Metric | LIFO | FIFO |
| --- | --- | --- |
| COGS | ₹7,000 | ₹6,200 |
| Ending Inventory | ₹4,000 | ₹4,800 |

## LIFO vs FIFO vs Weighted Average Cost

| Criteria | LIFO | FIFO | Weighted Average Cost |
| --- | --- | --- | --- |
| Cost used first | Latest purchase cost | Oldest purchase cost | Average cost |
| COGS during inflation | Higher | Lower | Moderate |
| Closing inventory during inflation | Lower | Higher | Moderate |
| Profit during inflation | Lower | Higher | Moderate |
| IFRS | Not permitted | Permitted | Permitted |
| Ind AS | Not permitted | Permitted | Permitted |
| US GAAP | Permitted | Permitted | Permitted |
| Best suited for | US businesses with rising or volatile inventory costs | Perishables, FMCG, retail, and global reporting | Indian SMBs, manufacturing, and mixed purchase batches |

## **Is LIFO Allowed in India?**

No. LIFO is not allowed for inventory valuation in India. For companies following Ind AS, [**Ind AS 2**](https://busy.in/accounting/indian-accounting-standards-applicability-list/) permits the use of FIFO or Weighted Average Cost for inventories that are ordinarily interchangeable. For entities following AS 2, ICAI’s AS 2 also says inventory cost, other than specifically identifiable inventory, should be assigned using FIFO or Weighted Average Cost. For income tax computation, [ICDS-II](https://www.incometaxindia.gov.in/income-computation-and-disclosure-standards-icds-1) lists Specific Identification, FIFO, and Weighted Average Cost as methods for measuring inventory cost. LIFO is not included in the listed methods.

This means that Indian businesses **should not** treat LIFO as a usable inventory valuation method for regular accounting or tax reporting. For India, the practical choices are usually: FIFO, Weighted Average Cost, and Specific Identification, where inventory items are not interchangeable. Using reliable [**accounting software**](https://busy.in/accounting-software/) helps maintain purchase records, stock movement, closing inventory, and accounting reports in one place.

For Indian businesses using FIFO or Weighted Average Cost, accounting and [**inventory management software**](https://busy.in/accounting-software/inventory-management/) like BUSY can automatically track purchase batches, calculate stock values, generate inventory reports, and maintain records needed for GST compliance and annual reconciliation, without requiring manual layer-by-layer calculations.

## **LIFO Under US GAAP**

LIFO is mainly relevant in the United States because US GAAP allows it. It is often used by businesses that deal with rising or volatile inventory costs. However, US tax rules have a LIFO conformity requirement. If a taxpayer uses LIFO for US [**income tax reporting**](https://busy.in/accounting/taxation-in-accounting-basics-types-of-taxes-and-compliance-essentials/) , they generally must also use LIFO for financial statement reporting, subject to specific exceptions.

This is important because a business cannot simply use LIFO for tax savings and then report a different primary profit figure in its [**financial statements**](https://busy.in/accounting/financial-accounting/) without considering the conformity rule.

## **What is LIFO Reserve?**

LIFO Reserve is the difference between the inventory value under FIFO and the inventory value under LIFO. LIFO Reserve is mainly useful for analysts comparing companies that use different inventory methods. US reporting guidance also requires [**additional disclosures**](https://busy.in/accounting/accounting-policies-what-they-are-and-why-they-matter-in-financial-reporting/) for entities using LIFO, including a material excess of replacement or current cost over the reported LIFO value and, where applicable, income from LIFO liquidation.

**Formula: LIFO Reserve = FIFO Inventory Value - LIFO Inventory Value**

Example: Inventory reported under LIFO here is ₹12,00,000 lower than it would be under FIFO.

| Inventory Basis | Value |
| --- | --- |
| FIFO Inventory | ₹62,00,000 |
| LIFO Inventory | ₹50,00,000 |
| LIFO Reserve | ₹12,00,000 |

## **What is LIFO Liquidation?**

LIFO Liquidation happens when a company sells more inventory than it buys or produces during a period. This forces the company to use old inventory cost layers. If those old layers have much lower costs, COGS becomes unusually low, and profit becomes unusually high. This is why [**analysts and auditors**](https://busy.in/accounting/accounting-vs-auditing-key-differences-and-why-they-matter/) pay attention to LIFO liquidation. It may show that profit increased because older cost layers were used, not because the business performed better.

Example:

| Inventory Layer | Units | Cost per Unit |
| --- | --- | --- |
| Old layer | 500 | ₹200 |
| New layer | 300 | ₹400 |

The company sells 700 units.

Under LIFO:

| Layer Used | Units | Cost per Unit | COGS |
| --- | --- | --- | --- |
| New layer | 300 | ₹400 | ₹1,20,000 |
| Old layer | 400 | ₹200 | ₹80,000 |
| Total COGS | 700 |  | ₹2,00,000 |

If all 700 units had been costed at the current ₹400 rate, COGS would have been ₹2,80,000. So the LIFO liquidation makes profit look ₹80,000 higher.

## **Perpetual vs Periodic LIFO: What's the Difference?**

| Point | Perpetual LIFO | Periodic LIFO |
| --- | --- | --- |
| When COGS is calculated | At each sale | At period end |
| Cost layer used | Latest cost available on sale date | Latest cost available during the full period |
| Result | More transaction-level detail | May give a different COGS figure |
| Best suited for | Real-time inventory systems | Manual or period-end inventory systems |

## **Impact of Inflation on LIFO**

| Price Environment | Effect on COGS | Effect on Profit | Effect on Inventory |
| --- | --- | --- | --- |
| Inflation | COGS increases | Profit decreases | Closing inventory may show older, lower costs |
| Deflation | COGS may decrease | Profit may increase | Closing inventory may include older, higher-cost layers |
| Stable prices | Difference is small | Difference is small | Difference is small |

## Explore All BUSY Calculators for Easy GST Compliance

[Gst calculator](https://busy.in/calculators/gst-calculator/) | [Vendor GSTIN validation tool](https://busy.in/calculators/gst-validation-tool/) | [ITC calculator](https://busy.in/calculators/itc-calculator/) | [Profit margin calculator](https://busy.in/calculators/profit-margin-calculator/) | [EMI calculator](https://busy.in/calculators/business-emi-calculator/) | [Inventory turnover calculator](https://busy.in/calculators/inventory-turnover-calculator/) | [Annual return calculator](https://busy.in/calculators/roi-calculator/) | [E way bill template](https://busy.in/download-e-way-bill-template/)

## **Conclusion**

LIFO is an inventory valuation method in which the most recent purchase costs are assigned to [**Cost of Goods Sold**](https://busy.in/accounting/how-to-create-an-income-statement-format-components-and-sample-template/) first. It can reduce reported profits during periods of inflation and may create [**tax benefits**](https://busy.in/accounting/tax-accounting/) where legally allowed. However, LIFO is not allowed under IFRS, Ind AS, [AS 2](https://www.icai.org/resource/23698IndAS-2.pdf) , or Indian tax inventory computation under ICDS-II. For Indian businesses, FIFO and Weighted Average Cost are the practical and compliant inventory valuation methods.

LIFO remains important to understand because it affects [**financial statement analysis**](https://busy.in/accounting/accounting-ratios-definitions-and-different-types/) , especially when comparing US companies with those reporting under IFRS or Indian standards.

## About the author

**Shivani Kandalkar**

I’m CA Shivani Kandalkar, a Chartered Accountant based in Mumbai with over 1 year of experience. My focus areas are Taxation and GSTR compliance, where I help individuals and businesses file accurate returns and avoid notices. With a background in M.Com and professional training as a Chartered Accountant, I aim to provide clear, practical guidance that simplifies tax laws and supports better financial decisions.

## Frequently asked questions

### What is the LIFO method?

LIFO stands for Last-In, First-Out. It means the latest inventory costs are assigned to Cost of Goods Sold first.

### Is LIFO the same as selling the newest physical stock first?

No. LIFO is mainly an accounting cost flow assumption. It does not always describe the actual physical movement of goods.

### How is LIFO COGS calculated?

LIFO COGS is calculated by taking the cost of the most recent inventory layer first, then moving backwards to older layers until the total sold quantity is covered.

### Is LIFO allowed in India?

No. LIFO is not allowed for inventory valuation in India. Indian businesses should use permitted methods such as FIFO or Weighted Average Cost.

### Is LIFO allowed under IFRS?

No. IAS 2 does not permit LIFO. It allows FIFO or Weighted Average Cost for ordinarily interchangeable inventory.

### Is LIFO allowed under US GAAP?

Yes. US GAAP allows LIFO, FIFO, and Weighted Average Cost. However, companies using LIFO for US tax purposes must consider the LIFO conformity rule.

### What is LIFO Reserve?

LIFO Reserve is the difference between inventory value under FIFO and inventory value under LIFO. It helps analysts compare companies using different inventory valuation methods.

### What is LIFO Liquidation?

LIFO Liquidation happens when a company sells more inventory than it purchases or produces, forcing it to use older cost layers. This can make profit look unusually high.

### Which method is better for Indian businesses: LIFO, FIFO, or Weighted Average?

For Indian businesses, LIFO is not an option. [FIFO](https://busy.in/inventory-guide/what-is-the-fifo-method/) and Weighted Average Cost are the practical choices. FIFO is useful when stock movement follows older goods first. Weighted Average Cost is useful when the same item is purchased frequently at different prices.

### What is the main disadvantage of LIFO?

The main disadvantage of LIFO is that it can understate inventory value during inflation because closing stock is valued at older, lower costs. LIFO can also create distorted profit figures when LIFO Liquidation occurs

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