What Is a LIFO Liquidation? Understanding LIFO Liquidation with Example

What is a LIFO Liquidation?

LIFO Liquidation is the process of selling older goods or commodities in a company's products at a discount. Businesses that use the Last In, First Out (LIFO) inventory approach this. When a corporation uses LIFO and the liquidation happens, it has to swiftly get rid of aged and perhaps outdated stocks.

Understanding LIFO Liquidation

The LIFO approach is a financial strategy in which a business sells its most recently bought goods first. The LIFO method compares the latest expenses to the latest income. Some organizations adopt the LIFO strategy at the time of purchasing goods costs rise. The LIFO system has tax advantages since the greater expenses of new inventory appear to balance earnings, due to smaller taxation.

A few key LIFO terminologies are listed below -

Layer
Reserve
Inventory pool

In general, organizations that use the LIFO approach for pricing their inventories in the business bought sufficient stock based on market sales and profits to meet customer expectations in the same week. But there are instances when, for unknown reasons, there is a sudden increase in demand for a product category, and in order to meet that demand, the firm must use up its old inventory, acquired at a lower cost than the current monthly rate.

Typically, the cost of raw materials rises with the passage of time. Because of the LIFO liquidation event, the final accounts' cost of goods sold is lower, resulting in higher profit.

Practical Example

For domestic outlets, ABC company adopts the LIFO technique of inventory reporting. In April, it bought 100000 units of a product. Week one costs $5 per unit, week two costs $7, week three costs $12, and week four costs $15. The weekly purchase quantity is 25000 units. Each unit costs $14.50 at ABC. In May, it sold 20,000 units of the product. The items that were sold were from week four. As a result, it was purchased and sold using the LIFO approach.