The basic concept underlying perpetual LIFO is the last in, first out (LIFO) cost layering system. Under LIFO, you assume that the last item entering inventory is the first one to be used. For example, consider stocking the shelves in a food store, where a customer purchases the item in front, which was likely to be the last item added to the shelf by a clerk. These LIFO transactions are recorded under the perpetual inventory system, where inventory records are constantly updated as inventory-related transactions occur.
The only difference between the two cost flow concepts is how rapidly a costing layer is stripped away or replenished in the costing database. Under perpetual LIFO, there can be a great deal of this activity throughout a reporting period, with inventory layers being added and eliminated potentially as frequently as every day. This means that the costs at which items are sold could vary throughout the period, since costs are being drawn from the most recent of a constantly varying set of cost layers.
Under a periodic LIFO system, however, layers are only stripped away at the end of the period, so that only the very last layers are depleted.
For example, ABC International acquires 10 green widgets on January 15 for $5, and acquires another 10 green widgets at the end of the month for $7. ABC sells five green widgets on January 16. Under a perpetual LIFO system, you would charge the cost of the five widgets sold on January 16 to the cost of goods sold as soon as the sale occurs, which means that the cost of goods sold is $25 (5 units x $5 each). Under a periodic LIFO system, you would wait until the end of the month and then record the sale, which means that you remove five units from the last layer recorded at the end of the month, which results in a charge to the cost of goods sold of $35 (5 units x $7 each).
In a period of continually increasing prices, a periodic LIFO system will result in the highest cost of goods sold and therefore the lowest net income, since it will always use up the most recently purchased inventory first. Conversely, in a period of decreasing prices, the reverse would be true.
The costing results of a perpetual LIFO system are more common than a periodic LIFO system, since most inventory is now tracked using computerized systems that maintain inventory records on a real-time basis.