LIFO Method: How to Calculate Inventory Layer by Layer

The LIFO method assigns the newest inventory costs to cost of goods sold first, leaving older costs in ending inventory. Work backward through the cost layers until every unit sold has a cost. LIFO is allowed in the United States when its rules are met, but IFRS does not permit it.

What each input means

A cost layer is a group of units acquired at one unit cost. List each layer with its date, quantity, and cost. Under LIFO, dates determine the order in which costs leave inventory.

Units sold determine how far backward you travel through the layers. If a sale uses an entire layer, continue to the next-newest one. If it uses only part of a layer, carry the unused portion into ending inventory.

Periodic or perpetual timing matters. Periodic LIFO treats all purchases for the period as available when calculating period-end COGS. Perpetual LIFO applies the newest layer actually on hand at each sale date. The two can produce different amounts.

Periodic LIFO worked example

A campus bookstore begins September with 75 identical calculators costing $14.60 each. It purchases 110 at $15.25 and later 95 at $16.10. It sells 205 units during the month. Under periodic LIFO, all 280 units are considered together at period-end.

Start with the newest layer: assign all 95 units at $16.10 to COGS. Another 110 units are needed, so assign the full $15.25 layer. That reaches 205 units sold. The oldest 75-unit layer remains.

The answer is $3,207 in COGS and $1,095 in ending inventory. If the 205 calculators sold for $24.50 each, revenue is $5,022.50 and gross profit is $1,815.50. Revenue uses the selling price; the LIFO schedule supplies only product cost.

Why perpetual LIFO can differ

Suppose 100 units were sold before the $16.10 purchase occurred. Perpetual LIFO could not assign that later purchase to the earlier sale. It would use the newest inventory available on the sale date, then update the layers before processing the next transaction. Periodic LIFO, by contrast, waits until month-end and can assign later purchases to the total units sold during the period.

For a perpetual problem, process every event by date. Purchases add layers. Sales remove units beginning with the newest layer currently present. Do not combine all sales before checking when each purchase arrived. This timing issue is one of the most common reasons two correct-looking LIFO schedules disagree.

Effect when prices rise or fall

In this example, costs rise from $14.60 to $16.10. LIFO therefore sends the higher recent costs to COGS. Compared with FIFO, it reports higher COGS, lower gross profit, and lower ending inventory. Under falling prices, the direction reverses because the newest costs would be lower.

LIFO can make ending inventory contain old costs that differ substantially from recent purchase prices. That is not a calculation error; it follows from retaining old layers. If inventory falls below a previous level, old layers can enter COGS in a LIFO liquidation, sometimes increasing reported profit because old low costs are released.

Where LIFO is permitted

U.S. GAAP permits LIFO. For U.S. federal tax, Internal Revenue Code section 472 and related rules govern its use, and a taxpayer generally files Form 970 to elect the method. The conformity requirement also prevents a business from using LIFO only on its tax return while presenting a different inventory method in covered financial reports. Real adoption or a change in method requires tax and accounting advice beyond a textbook layer calculation.

IFRS does not permit LIFO. IAS 2 identifies specific identification where appropriate and FIFO or weighted average for ordinarily interchangeable inventory. A company reporting under IFRS must therefore use a permitted formula even if LIFO would reduce profit during inflation.

Common mistakes

Confusing LIFO with physical flow. LIFO is a cost assumption. A grocer may physically sell older products first while a U.S. accounting policy assigns recent costs to COGS.

Starting with beginning inventory. That is FIFO logic. For LIFO, begin with the newest eligible layer.

Ignoring transaction dates in a perpetual system. A future purchase cannot supply the cost of an earlier sale. Recalculate the layer stack after each transaction.

Applying the price-trend rule mechanically. LIFO gives lower profit only when costs are rising. Say whether prices rise or fall before predicting the effect.

Skipping the two checks. Units available must equal units sold plus units left. COGS plus ending inventory must equal total cost available. In the example, 280 equals 205 plus 75, and $4,302 equals $3,207 plus $1,095.

Building a LIFO layer schedule

Use one row for each acquisition date and keep the rows in chronological order. In a periodic problem, mark units sold against rows from the bottom upward at period-end. In a perpetual problem, draw a line after every sale and use only the rows above that line. The line prevents a later purchase from being assigned to an earlier sale.

When a sale uses part of a layer, keep the unused quantity at the original unit cost. Suppose a newest layer contains 95 units at $16.10 and a sale needs only 60. COGS receives $966, while 35 units at $16.10 remain in the layer. Do not average those 35 units with older inventory; that would introduce weighted-average logic into a LIFO schedule.

A perpetual sale normally creates two entries. Record sales revenue at the selling price, then debit COGS and credit Inventory for the LIFO layer cost assigned to that sale. Keeping the revenue entry separate explains why changing the inventory method affects gross profit through COGS but does not change revenue.

When comparing years, watch inventory quantities as well as prices. If quantities shrink enough to consume an old LIFO layer, its old cost enters current COGS. During a period of rising costs, releasing a low-cost layer can raise current profit. This LIFO liquidation effect means a simple statement such as “LIFO always lowers profit during inflation” is incomplete when old layers are being depleted.

By the FinanceBrain Team · Last verified July 12, 2026 · How we produce and verify articles