Published on August 4th, 2022 | by Sunit Nandi

Everything You Need to Know About LIFO Accounting

Doing business nowadays can be challenging and difficult, especially with the costs that inflation in the country has brought about. The soaring prices of commodities as well as materials and supplies for a given product have made it almost impossible not to raise prices and if you do, it might also decrease your customers and sales as most people would look for the cheapest prices in the market. thus, to keep afloat, one must be able to find innovative and creative ways to save resources and generate additional capital. One such way is to make use of accounting principles to reduce federal and state tax liabilities which could mean an influx of capital for your company. If you have multiple businesses in a certain niche or you own a business with a variety of industries, then you can probably use the LIFO accounting method. It is a reality that your inventory is your most valuable asset, and it can also be the most significant line item on your balance sheet. The accounting method referred to as LIFO can be used as a tool to generate cash for the company by being a profitable source and using it as leverage. LIFO stands for Last In, First Out, and it refers to a method of accounting that assumes newly purchased inventory is sold ahead of previously purchased inventory. During periods of rising inflation, higher-priced inventory is expected to be sold and distributed, while earlier and lower-priced products are expected to be part of the ending inventory. The LIFO method has no influence on actual product distribution; it is simply a cost flow method for accounting, and a company is not required to keep old stock in inventory in order to reap tax benefits. By using the higher-priced inventory first, you are able to keep the margin of your inventory a bit higher and hence have more value which can translate into higher tax benefits. By doing that, the company will be able to generate additional cash flow by reducing tax liabilities for a given quarter.

How does LIFO Accounting work?

LIFO accounting is a method that can generate tax savings at the end of the year when reporting income from inventory. This just means that inventory that is acquired last, will be the first to be sold off. The inventory that will remain will be the oldest one, which the government converts into tax savings. There is no rule to say that you cannot hold on to older inventory and this method is legal and even practiced by many companies to cut back on tax liabilities. At the end of the year, the LIFO reserves or the difference in prices of the older inventory can serve as an additional income source. For example, when you purchased inventory at the start of the year for 10 dollars and the end of the year, the same inventory costs 12 dollars you can realize a difference of 2 dollars per inventory, which could then be converted into tax savings. If you are a business owner looking into ways to generate more cash flow then using LIFO accounting is the answer to your problems. You can adopt the LIFO accounting method for a given year but if you are not yet using it then you need to file for a change in accounting method first. If your current accountant is not well-versed in this method, then you need to work with an accounting firm that can help you with the LIFO method. There are a handful of firms that specialize in LIFO and you can visit them for a consultation before you even commit to changing the way you do accounting for your businesses.

What are LIFO Accounting Firms?

Generally, an accounting firm is a provider of accounting services for businesses of every size, although the bigger companies usually have their accounting department, for medium and small-scale businesses, it is best to contract the services of an accounting firm as the work is often seasonal and hiring a full-time accountant might not be a viable option for the business. These accounting firms are experts in their field and will be able to help you prepare your income statements, get your books in order and prepare and file your taxes among others. Another specialty they have is in the different types of accounting methods and one of them is LIFO accounting. If you decide to use this method, then communicate it with your accounting firm if they can do it, if not then you can look for another firm that will be able to do it for you. You can find them online if you are not sure if the firms in your area can do it, and outsourcing this part of your business is safe and legal so you do not have to worry about it being shady or illegal.

What to look for in a LIFO accounting firm?

Most of the time, what matters most is in the details, so when you try to scout for possible LIFO accounting firms to work with, take note of the firms that can explain to you what LIFO accounting is and how it can benefit you and your business. They should be able to discuss well the mechanisms involved in this method and provide you with different examples and ways in which to demonstrate the benefits of the method to your cash flow. Be able to ask questions and prepare those questions so you would know what to ask at any given time, and do not worry if you have plenty of questions, the consultations are usually free and each firm would want you to be their client, so you do not have to make a choice right then and there. Then there is the matter of the firm’s rates and how much it would cost you to retain their services, at a time when finances are tight, you need to do a cost-benefit analysis on this, and think about which firm would give you more value for your money.

Tags: bookkeeping, last in first out, LIFO

About the Author

Sunit Nandi I'm the leader of Techno FAQ. Also an engineering college student with immense interest in science and technology. Other interests include literature, coin collecting, gardening and photography. Always wish to live life like there's no tomorrow.