Last-In, First-Out Inventory Valuation Method

According to Last-In, First-Out (LIFO) inventory valuation method the cost of goods sold is the cost of those goods that have been purchased last. The ending inventory is valued at the earlier cost. It is based on the assumption that the goods sold are those that have been acquired last and the goods that remain unsold (ending inventory) are those that have been acquired first. So cost of goods sold is based on the price of recently purchased goods and the ending inventory represents the cost of earlier purchases.

The main purpose of inventory valuation is to match costs of goods sold or produced with the revenues they generate. LIFO method aims to match the current costs of acquiring or producing the goods with the current revenues from the sales. The cost of goods sold under this method represents the cost of recent purchases with the result that there is better matching of current costs with current revenues. However, this method of inventory valuation understates the assets because the ending inventory on the assets side of the balance sheet is valued at old and out of date unit costs.