Periodic LIFO

"Periodic" means that the Inventory account is not updated during the accounting period. Instead, the cost of merchandise purchased from suppliers is debited to an account calledPurchases. At the end of the accounting year the Inventory account is adjusted to equal the cost of the merchandise that is unsold. The other costs of goods will be reported on the income statement as the cost of goods sold.

"LIFO" is an acronym for Last In, First Out. Under the LIFO cost flow assumption, the last (or recent) costs are the first ones to leave inventory and become the cost of goods sold on the income statement. The first (or oldest) costs will be reported as inventory on the balance sheet.

Remember that the costs can flow differently than the goods. In other words, if Corner Shelf Bookstore uses LIFO, the owner may sell the oldest (first) book to a customer, but can report the cost of goods sold of $90 (the last cost).

It's important to note that under LIFO periodic (not LIFO perpetual) we wait until the entire year is over before assigning the costs. Then we flow the year's last costs first, even if those goods arrived after the last sale of the year. For example, assume the last sale of the year at the Corner Shelf Bookstore occurred on December 27. Also assume that the store's last purchase of the year arrived on December 31. Under LIFO periodic, the cost of the book purchased on December 31 is sent to the cost of goods sold first, even though it's physically impossible for that book to be the one sold on December 27. (This reinforces our previous statement that the flow of costs does not have to correspond with the physical flow of units.)

Let's illustrate periodic LIFO by using the data for the Corner Shelf Bookstore:

Number of Books Cost per Book Total Cost Inventory at Dec. 31, 2010 1 @ $85 = $  85 First purchase (January 2011) 1 @ 87 = 87 Second purchase (June 2011) 2 @ 89 = 178 Third purchase (December 2011) 1 @ 90 =     90 Total goods available for sale 5 $440 Less: Inventory at Dec. 31, 2011 4 - 350 Cost of goods sold 1 @ $90 $  90

As before we need to account for the total goods available for sale: 5 books at a cost of $440. Under periodic LIFO we assign the last cost of $90 to the one book that was sold. (If two books were sold, $90 would be assigned to the first book and $89 to the second book.) The remaining $350 ($440 - $90) is assigned to inventory. The $350 of inventory cost consists of $85 + $87 + $89 + $89. The $90 assigned to the book that was sold is permanently gone from inventory.

If the bookstore sold the textbook for $110, its gross profit under periodic LIFO will be $20 ($110 - $90). If the costs of textbooks continue to increase, LIFO will always result in the least amount of profit. (The reason is that the last costs will always be higher than the first costs. Higher costs result in less profits and usually lower income taxes.)