Perpetual LIFO

Under the perpetual system the Inventory account is constantly (or perpetually) changing. When a retailer purchases merchandise, the retailer debits its Inventory account for the cost of the merchandise. When the retailer sells the merchandise to its customers, the retailer credits its Inventory account for the cost of the goods that were sold and debits its Cost of Goods Sold account for their cost. Rather than staying dormant as it does with the periodic method, the Inventory account balance is continuously updated.

Under the perpetual system, two transactions are recorded at the time that the merchandise is sold: (1) the sales amount is debited to Accounts Receivable or Cash and is credited to Sales, and (2) the cost of the merchandise sold is debited to Cost of Goods Sold and is credited to Inventory. (Note: Under the periodic system the second entry is not made.)

With perpetual LIFO, the last costs available at the time of the sale are the first to be removed from the Inventory account and debited to the Cost of Goods Sold account. Since this is the perpetual system we cannot wait until the end of the year to determine the last cost—an entry must be recorded at the time of the sale in order to reduce the Inventory account and to increase the Cost of Goods Sold account.

If costs continue to rise throughout the entire year, perpetual LIFO will yield a lower cost of goods sold and a higher net income than periodic LIFO. Generally this means that periodicLIFO will result in less income taxes than perpetual LIFO. (If you wish to minimize the amount paid in income taxes during periods of inflation, you should discuss LIFO with your tax adviser.)

Once again we'll use our example 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 - 351 Cost of goods sold 1 @ $89 $  89

Let's assume that after Corner Shelf makes its second purchase in June 2011, Corner Shelf sells one book. This means the last cost at the time of the sale was $89. Under perpetual LIFO the following entry must be made at the time of the sale: $89 will be credited to Inventory and $89 will be debited to Cost of Goods Sold. If that was the only book sold during the year, at the end of the year the Cost of Goods Sold account will have a balance of $89 and the cost in the Inventory account will be $351 ($85 + $87 + $89 + $90).

If the bookstore sells the textbook for $110, its gross profit under perpetual LIFO will be $21 ($110 - $89). Note that this is different than the gross profit of $20 under periodic LIFO.