How to Determine the Gross Profit for a Month Using LIFO Method

The LIFO method is a way of accounting for inventory.

Last in, first out (LIFO) is a method used to assign costs to inventory items. As its name states, LIFO applies the most recent inventory costs to inventory that has been sold (cost of goods sold), while ending inventory is valued using the oldest costs. Since cost of goods sold is used to determine gross profit, using LIFO will result in lower revenues and taxes when prices are increasing. LIFO provides a better match between current revenues and current expenses, but it can also manipulate income if inventory purchases are intentionally reduced to use old cost layers to value inventory sold. The use of LIFO to value costs of goods sold will affect the gross profit amount for a given period, as can the type of inventory system used.

Instructions

1. Determine sales for the period. You will use the amount of earned sales to calculate gross profit.

2. Calculate cost of goods sold, under a periodic inventory system. The use of LIFO to assign costs to inventory is affected by the type of inventory system used. There are two types of inventory systems -- periodic and perpetual. If a perpetual inventory system is used, skip this step and go to Step 3. The periodic system uses a purchases account; a temporary account that is debited every time inventory is purchased. At the end of an accounting period, ending inventory is valued by taking a physical count and assigning the oldest unit costs to the inventory. To arrive at cost of goods sold, calculate cost of goods available for sale by taking the beginning inventory balance and adding purchases. Using the cost of goods available for sale total, subtract ending inventory to arrive at cost of goods sold.

3. Obtain cost of goods sold under a perpetual inventory system. If a periodic inventory system is used, skip this step and go to Step 4. A perpetual system doesn't use a purchases account and it keeps a running total of the inventory balance. Every purchase is recorded to the inventory account and every sale is recorded to a cost of goods sold account as well as inventory. Under LIFO, the latest unit price is automatically assigned to inventory when it is sold and ending inventory will end up valued at the oldest unit cost. Since a perpetual system uses a cost of goods sold account, you don't need to calculate this amount. Use the balance in cost of goods sold at the end of the period.

4. Use the sales amount from Step 1 and subtract cost of goods sold calculated in Step 2 or determined in Step 3 to arrive at gross profit for the period.

Tips & Warnings

• Under LIFO, a periodic inventory system will result in a lower ending inventory and higher cost of goods sold than under a perpetual inventory system when prices are rising.

References

• "Financial: CPA Exam Review"; DeVry/Becker Educational Development Corp.; 2009

Resources

• "Journal of Accountancy"; The Death of LIFO?; January 2009