Definition: An accounting method for inventory and cost of sales in which the last items produced or purchased are assumed to be sold first; allows business owner to value inventory at the less expensive cost of the older inventory; typically used during times of high inflation .
The LIFO method of accounting assumes that you'll sell the most recently purchased inventory first. For instance, suppose you bought 10 ceiling fans a year ago at $30 each. A week ago, you purchased a second lot of 10 ceiling fans, but now the price has gone up to $50 each. By using the LIFO method, you sell your customers the $50 ceiling fans first, which allows you to keep the less expensive units (in terms of your inventory cost) in inventory. Then, when you have to calculate inventory value for tax purposes, LIFO allows you to value your remaining inventory (the $30 fans) at substantially less than the $50 fans, so you pay less in taxes. The advantage of using this accounting method is that the cost of sales in a period will closely match the current period values of your inventory; the drawback is that this method values inventory at old cost levels.
See also "First In, First Out (FIFO)."