11.1 Last-In, First-Out (LIFO), Layers & Liquidation

Why LIFO is a Part 3 skill

AIPB’s Certified Bookkeeper path tests inventory as Part 3: an untimed, open-book multiple-choice final in the Mastering Inventory workbook, passing grade 70%, with no extra exam fee. AIPB’s certification and 99-hour course pages name last-in, first-out (LIFO) beside FIFO, weighted-average, moving-average, and lower of cost or net realizable value (LCNRV). This independent OpenExamPrep chapter teaches those costing and valuation skills. It is not an AIPB publication and does not claim official approval, review, partnership, or exact equivalence with AIPB, the CB exam, or any workbook.

Chapter 10 taught first-in, first-out (FIFO) and the perpetual versus periodic recording systems. This section switches the cost-flow assumption to LIFO on a new data set. Do not reuse Chapter 10’s layers. The units, dates, and dollar costs below belong to Quarry & Wick Outfitters. LIFO is a cost-flow assumption, not a claim about which carton the warehouse hands the customer. Goods can leave in any physical order. LIFO assigns the most recently incurred unit costs to cost of goods sold (COGS) and leaves older unit costs in ending inventory.

In a period of rising purchase prices—the usual exam setting—LIFO produces higher COGS and lower ending inventory than FIFO on the same purchases and sales. That is not a bookkeeping error. It is the mechanical result of peeling cost from the newest invoices first. The same arithmetic is why LIFO can reduce U.S. taxable income (with a conformity catch described later) and why IFRS (IAS 2) does not allow LIFO.

Last-in, first-out in one sentence, then in layers

LIFO means the last unit costs that came in are the first unit costs that go out to COGS. What remains on the balance sheet is a stack of LIFO layers: the beginning inventory layer plus any later purchases that were never fully sold.

A layer is a batch of units that entered at a distinct unit cost (or a distinct purchase date you track as one cost). Under periodic LIFO you do not assign cost until period-end. Under perpetual LIFO you assign cost at each sale, using only the layers that exist at that moment. Those two timings can produce different ending inventory and COGS. FIFO perpetual and FIFO periodic often agree on a simple dated card; LIFO perpetual and LIFO periodic often do not. That difference is a favorite exam trap.

Quarry & Wick Outfitters — January activity (new layers, not Chapter 10)

Quarry & Wick sells a single SKU of trail stoves. January is a rising-price month. Unit cost already includes invoice price and inbound freight.

Goods available for sale: 40 + 60 + 80 + 50 = 230 units.
Cost of goods available: $720 + $1,200 + $1,840 + $1,250 = $5,010.
Units sold: 45 + 70 + 55 = 170.
Units in ending inventory: 230 − 170 = 60.

Those four control totals must foot under every cost-flow method. Methods change which dollars sit in the 60 units versus the 170 units. They do not change units available, units sold, or the $5,010 pool.

Periodic LIFO — wait until month-end, then peel from the newest invoices

A periodic system does not assign cost at each sale. At January 31 you take the count of 60 units and cost them as the oldest 60 units still in the $5,010 stack, because LIFO says the newest 170 units were sold.

Oldest 60 units:

• All 40 beginning units @ $18 = $720
• 20 units from the Jan 8 purchase @ $20 = $400
• Periodic LIFO ending inventory = $1,120

Periodic LIFO COGS = $5,010 − $1,120 = $3,890.

Cross-check by costing the newest 170 units as COGS:

• 50 (Jan 25) @ $25 = $1,250
• 80 (Jan 18) @ $23 = $1,840
• 40 remaining sold from Jan 8 @ $20 = $800
• 50 + 80 + 40 = 170
• COGS = $1,250 + $1,840 + $800 = $3,890

The Jan 1 $18 layer is untouched. That is the point of LIFO in inflation: old cheap costs remain as an inventory layer.

Periodic timing: purchases sit in Purchases (or Inventory, depending on how the firm records). COGS is computed at period-end: beginning inventory + net purchases − ending inventory. There is no COGS entry on Jan 12, Jan 22, or Jan 28 under a pure periodic system.

Perpetual LIFO — peel at each sale from the newest layer then on hand

Perpetual LIFO assigns cost when the sale happens, using only purchases that have already arrived. A sale on Jan 12 cannot grab the Jan 25 $25 units; those stoves are not in the warehouse yet.

After Jan 1: 40 @ $18.
Jan 8 purchase: 40 @ $18 + 60 @ $20.

Jan 12 sale of 45: newest layer on hand is the $20 purchase. Take 45 @ $20 = $900 COGS.
Remaining: 40 @ $18 + 15 @ $20.

Jan 18 purchase: 40 @ $18 + 15 @ $20 + 80 @ $23.

Jan 22 sale of 70: newest layer is $23. Take 70 @ $23 = $1,610 COGS.
Remaining: 40 @ $18 + 15 @ $20 + 10 @ $23.

Jan 25 purchase: 40 @ $18 + 15 @ $20 + 10 @ $23 + 50 @ $25.

Jan 28 sale of 55: newest is $25, but that layer is only 50 units. Take 50 @ $25 = $1,250 and 5 @ $23 = $115. Sale COGS = $1,365.
Remaining: 40 @ $18 + 15 @ $20 + 5 @ $23.

Perpetual LIFO COGS = $900 + $1,610 + $1,365 = $3,875.
Check: $5,010 − $1,135 = $3,875.

Jan 12 perpetual LIFO entry:

Dr Cost of Goods Sold 900
Cr Merchandise Inventory 900

Why periodic LIFO and perpetual LIFO differ here

Periodic LIFO ending inventory is $1,120. Perpetual LIFO ending inventory is $1,135. The $15 gap is 5 units still sitting at $23 in the perpetual stack that periodic LIFO recosts as if they were extra $20 units from Jan 8:

5 × ($23 − $20) = $15.

Periodic LIFO pretends the firm waited until January 31, looked at the whole month, and assigned the newest month’s costs to all 170 sales. Perpetual LIFO respects the calendar: the Jan 12 sale happened before the $23 and $25 purchases existed. Exam items that give dates and ask for LIFO without saying periodic versus perpetual are incomplete. If the item is silent, read whether a running inventory card is shown (perpetual) or only a period-end count (periodic).

LIFO layers, LIFO liquidation, and why old cheap layers inflate income

A LIFO liquidation happens when sales exceed current-period purchases enough that COGS reaches back into old, lower-cost layers. Because those historical unit costs sit below current replacement cost, COGS is too low compared with replacing the goods, and gross margin and pretax income are too high. The extra reported profit is not from a better cash markup. It is from dipping into yesterday’s costs.

Mossback Camping Co. — worked liquidation

Mossback uses periodic LIFO. Layers on January 1, 2025:

During 2025 Mossback purchases 200 units @ $24 = $4,800 and sells 350 units. Units available = 500. Ending inventory = 150 units.

Periodic LIFO COGS peels newest first:

• 200 @ $24 = $4,800 (entire 2025 purchase)
• 100 @ $19 = $1,900 (entire 2024 layer)
• 50 @ $16 = $800 (part of the 2023 layer)
• COGS = $7,500

Ending inventory is the leftover oldest 150 units: 80 @ $12 + 70 @ $16 = $960 + $1,120 = $2,080.
Check: $4,780 + $4,800 − $2,080 = $7,500.

Now the counterfactual the exam wants. If Mossback had purchased 350 units @ $24 instead of 200, LIFO would assign all 350 sales to the $24 layer:

• COGS = 350 × $24 = $8,400
• Old layers would remain intact at $4,780

Pretax income is $900 higher because of the liquidation: $8,400 − $7,500 = $900.
Composition: 100 units × ($24 − $19) = $500, plus 50 units × ($24 − $16) = $400. The extra reported profit is layer dip, not extra cash from customers.

If Mossback is a C corporation at a 21% federal rate, that $900 of extra income (assuming LIFO books and tax) can produce about $189 of extra tax with no extra cash collections. Bookkeepers who celebrate a liquidation year because gross margin jumped are looking at the wrong cause.

LIFO reserve is the gap between inventory at FIFO (or current cost) and inventory at LIFO. On Quarry & Wick’s periodic figures, FIFO ending inventory of the newest 60 units is 50 @ $25 + 10 @ $23 = $1,480, and LIFO ending inventory is $1,120, so the reserve is $360. Section 11.2 puts FIFO, LIFO, and weighted average on one comparison. A liquidation shrinks the reserve and the shrink flows toward income.

Tax conformity, IFRS, and bookkeeper judgment

In the United States, IRC §472 LIFO is allowed for tax, but the LIFO conformity rule generally requires that if LIFO is used to compute taxable income, LIFO also be used for the primary financial statements. You cannot keep FIFO books for the bank and LIFO for the IRS on the same inventory. IFRS (IAS 2) prohibits LIFO. A dual-reporting group may need a U.S. LIFO method and an IFRS FIFO or average method. AIPB’s exam is a U.S. bookkeeping exam; compute LIFO when the item says LIFO.

Dollar-value LIFO pools layers in inflation-adjusted dollars rather than physical units. Know that it exists. The computation you must finish by hand is unit LIFO like Quarry & Wick and Mossback.

Realistic scenarios

Scenario A — missing dates. An owner emails “we sold 170 stoves and bought 190; cost them LIFO” with no dates. Periodic LIFO can be computed from totals. Perpetual LIFO cannot. Ask for a dated purchases-and-sales log before you build a card.

Scenario B — “the warehouse ships oldest first.” Physical FIFO picking does not force FIFO costing. Cost flow is a policy. Document it and apply it consistently.

Scenario C — a “great” margin year. Mossback’s 2025 purchases lagged sales because a supplier was back-ordered. Margin looks wonderful. You still record LIFO COGS at $7,500 if that is the method. Then you explain the liquidation so the owner does not spend the $900 as if it were cash markup.

Traps

• Treating LIFO as a physical shipping rule
• Using a later purchase’s unit cost on an earlier perpetual sale
• Assuming perpetual LIFO equals periodic LIFO (Quarry & Wick: $1,135 versus $1,120)
• Calling a LIFO liquidation a “loss” because old layers disappeared — it raises income
• Mixing FIFO unit counts with LIFO dollars on the same card
• Inventing an AIPB item count for Part 3; AIPB does not publish one