What is a LIFO liquidation?
A LIFO liquidation is when a company first sells the last inventory acquired. This happens when a business that uses the last in, first out (LIFO) inventory costing method liquidates its old LIFO inventory. LIFO liquidation occurs when current sales exceed purchases, resulting in the liquidation of any stock not sold in a previous period.
Key points to remember
- A LIFO liquidation is when a company first sells its last inventory.
- It is an accounting method that uses the cost of last in, first out (LIFO) cost method.
- LIFO compares the most recent costs with current revenues.
- Some companies use the LIFO method during periods of inflation when the cost of purchasing inventory increases over time.
How a LIFO liquidation works
The LIFO method is a financial practice in which a company sells the most recent stock purchased first. LIFO compares the most recent costs with current revenues. Some companies use the LIFO method during periods of inflation when the cost of purchasing inventory increases over time. The LIFO method offers tax advantages, as the higher costs associated with new stocks seem to offset the benefits, resulting in a lower tax burden.
LIFO liquidation example
ABC Company uses the LIFO method of inventory accounting for its national stores. He bought 1 million units of a product per year for three years. The unit cost is $ 10 the first year, $ 12 the second year and $ 14 the third year, and ABC sells each unit for $ 50. It sold 500,000 units of the product in each of the first three years, leaving a total of 1.5 million units on hand. Assuming that demand will remain constant, it purchases only 500,000 units in the fourth year at $ 15 per unit.
|Year of purchase||Cost per unit||Amount||Total cost|
|1||$ 10||1,000,000||$ 10,000,000|
|2||$ 12||1,000,000||$ 12,000,000|
|3||$ 14||1,000,000||$ 14,000,000|
|4||$ 15||500,000||$ 7,500,000|
Despite its forecasts, consumer demand for the product has increased; ABC sold 1,000,000 units in the fourth year. According to the LIFO method, 500,000 units of the fourth year are liquidated, which translates into revenues of $ 25 million, COGS of $ 7.5 million and gross profits of $ 17.5 million; and 500,000 third-year units are sold, resulting in revenues of $ 25 million, COGS of $ 7 million and gross profits of $ 18 million.
|Cost year||Quantity sold||Remaining quantity||Cost / unit||COGS||
Gross profit (income – COGS)
|4||500,000||0||$ 15||$ 7,500,000||$ 17,500,000|
|3||500,000||500,000||$ 14||$ 7,000,000||$ 18,000,000|