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

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:

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:

If the business sells 120 units, then under LIFO:

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

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

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

So in this example, LIFO gives higher COGS and lower closing inventory when prices are rising.

Is LIFO Allowed in India?

No. LIFO is not allowed for inventory valuation in India. For companies following Ind AS, Ind AS 2 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 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 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 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 , 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 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 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.

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 pay attention to LIFO liquidation. It may show that profit increased because older cost layers were used, not because the business performed better.

Example:

The company sells 700 units.

Under LIFO:

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?

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.

Impact of Inflation on LIFO

Conclusion

LIFO is an inventory valuation method in which the most recent purchase costs are assigned to Cost of Goods Sold first. It can reduce reported profits during periods of inflation and may create tax benefits where legally allowed. However, LIFO is not allowed under IFRS, Ind AS, AS 2 , 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 , especially when comparing US companies with those reporting under IFRS or Indian standards.