What Is a LIFO Liquidation?
Selling the most recent inventory a company has acquired is known as a LIFO liquidation. It happens when a business employing the last-in, first-out (LIFO) method of inventory costing sells its earlier LIFO inventory; when current sales surpass purchases, a LIFO liquidation occurs, meaning that any inventory unsold in a prior period is liquidated.
The Process of a LIFO Liquidation
A financial technique known as the LIFO approach requires a business to sell its most recent inventory acquisitions first. LIFO balances current revenues against the most recent costs. Several businesses employ the LIFO approach when inventory costs are rising, and there are inflationary periods. The lower tax burden arising from the LIFO approach is due to the increased expenses of new inventories appearing to balance earnings.
Example of LIFO Liquidation
For its domestic outlets, ABC Company accounts for inventory using the LIFO approach. It bought one million units of a particular product annually for three years. ABC sells each unit for $50, with the cost per unit being $10 in the first year, $12 in the second year, and $14 in the third year. The product was sold in 500,000 units each year for the first three years, leaving 1.5 million units available. At $15 per unit in year four, it only buys 500,000 units, assuming demand stays the same.
The product saw an upsurge in demand from consumers despite the forecast; in the fourth year, ABC sold one million copies. The liquidation of 500,000 units in year four yields revenues of $25 million, COGS of $7.5 million, and gross profits of $17.5 million under the LIFO method. Similarly, liquidating 500,000 units in year three yields revenues of $25 million, COGS of $7 million, and gross profits of $18 million.
Conclusion
- A LIFO liquidation occurs when a business sells its most recent inventory first.
- The accounting system uses the last-in, first-out (LIFO) inventory costing approach.
- LIFO compares the most recent costs to the most recent revenues.
- During periods of inflation, when the cost of purchasing goods rises over time, several businesses employ the LIFO approach.
