LIFO Inventory Accounting in a Period of Declining Prices

Abstract

W V THEN THE LAST-IN-FIRST-OUT or LIFO method of accounting for inventories is mentioned, most people are inclined to think of its effect on profits in periods of rising prices. They recognize the fact that, if there is an upward movement in the price level, profits under the LIFO method are not likely to be so large as if the first-in-first-out or FIFO method had been followed. The reason is that the cost used in computing the profit on the sales during the period is that of the most recently acquired goods, which is higher than the cost of the goods on hand at the beginning of the year, which would have been the cost to be first used under the FIFO method. Thus, as prices continue to go up, the costs that are charged into the cost of goods sold are the costs of the last goods acquired, and, therefore, the highest costs, whereas the goods in the inventory continue to be priced on the basis of the lower cost goods first acquired. Thus, the inventory might continue to be carried at the cost of the goods that were on hand at the time the LIFO method was begun. Many who have only an elementary concept of the LIFO method, without any understanding of its greater implications, have some idea of these basic facts regarding inventories and profits of companies on the LIFO basis during periods of rising prices. Few, however, have any idea of what takes place in a period of falling prices. The LIFO method was seldom heard of before the beginning of the upward trend in prices which began in the mid '30's and has continued with only minor interruptions until now. Accordingly, very few have had any experience with what is involved when the price level begins to decline.