What is LIFO? Definition & Manufacturing Examples

What is LIFO?

LIFO (Last In, First Out) is an inventory valuation and cost flow method where the most recently purchased or produced items are recorded as consumed or sold first. Under LIFO, the cost of the newest inventory is matched against current revenue, while the oldest inventory costs remain on the balance sheet.

In manufacturing, LIFO is primarily a financial accounting method rather than a description of physical material flow. Most manufacturers physically manage their inventory using FIFO (oldest material used first) for quality and freshness reasons, while using LIFO for financial reporting and tax purposes.

The primary advantage of LIFO is tax reduction during periods of rising prices. When material costs are increasing, LIFO assigns the higher, more recent costs to cost of goods sold (COGS), resulting in lower taxable income. During inflationary periods, this can produce significant tax savings compared to FIFO.

LIFO is permitted under U.S. Generally Accepted Accounting Principles (GAAP) but is prohibited under International Financial Reporting Standards (IFRS). This means LIFO is used primarily by U.S.-based manufacturers who report exclusively under GAAP.

How LIFO Works in Manufacturing

Under LIFO accounting, when inventory is consumed in production, the cost assigned to the consumed units is the cost of the most recent purchase — regardless of which physical units were actually used.

Consider a manufacturer that purchases steel bar stock at different prices over time. When 100 bars are issued to production, LIFO assigns the cost of the most recent 100 bars purchased, even though the warehouse may have physically issued older stock.

LIFO creates "LIFO layers" on the balance sheet. As inventory is built up over years at different cost levels, each year's remaining inventory forms a layer at that year's cost. The oldest layers at the lowest costs sit at the bottom of the balance sheet. If inventory levels drop below prior year levels, old low-cost layers are consumed ("LIFO liquidation"), which can create artificial profit spikes.

The LIFO Reserve is the difference between inventory valued at LIFO and what it would be valued at under FIFO. This reserve, disclosed in financial statements, represents the cumulative tax benefit of using LIFO. For large manufacturers, the LIFO reserve can be tens of millions of dollars.

LIFO Example

A manufacturer of steel brackets purchases flat stock throughout the year:

Total purchased: 2,000 sheets. Total cost: $92,500.

Annual production consumes 1,500 sheets, leaving 500 in ending inventory.

Under LIFO: The 1,500 consumed sheets are costed at the most recent prices first: 500 at $50, 500 at $48, 500 at $45 = $71,500 COGS. Ending inventory: 500 sheets at $42 = $21,000.

Under FIFO: The 1,500 consumed are costed at oldest prices: 500 at $42, 500 at $45, 500 at $48 = $67,500 COGS. Ending inventory: 500 sheets at $50 = $25,000.

LIFO produces $4,000 higher COGS, reducing taxable income by $4,000. At a 25% tax rate, this saves $1,000 in taxes for the year — on just one material item.

Why LIFO Matters for Production Scheduling

While LIFO is an accounting method, it intersects with production scheduling in important ways. LIFO inventory valuation affects financial metrics that influence scheduling decisions, such as the reported value of WIP and finished goods inventory.

Manufacturers using LIFO must be careful about LIFO liquidation — if production scheduling decisions reduce inventory below historical levels, old low-cost LIFO layers are consumed, creating unexpected taxable income. This means major scheduling changes that significantly draw down inventory should be coordinated with the finance team.

Scheduling software like Resource Manager DB helps planners optimize production levels and inventory, but the financial implications of inventory level changes under LIFO require collaboration between operations and finance.

Related Terms

• FIFO — the opposite method where oldest inventory is consumed first, preferred for physical flow
• Carrying Cost — inventory holding costs that LIFO affects through different balance sheet valuations
• Finished Goods — completed inventory whose valuation differs under LIFO vs FIFO

FAQ

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This term is part of our Manufacturing & Production Scheduling Glossary. Learn more about inventory management, scheduling, and manufacturing terminology.