Last-in, first-out (LIFO) is based on the principle that the last deliveries of a material to be received are the first to be used. If this is true, then no value changes occurs for older material when new materials are received. Because of the LIFO method, the older material is not affected by the higher prices of the new deliveries of material. If the older material is not affected, that means it is not valuated at the new material price. If the older material value is not increased, this stops any false any valuation of current inventory.
LIFO valuation enables the increased amount of material stock per fiscal year to be valuated seperately from the rest of material stock. This is important as it ensures that the new material is valuated at the correct amount, while old stock remains valuated without being affected by the new material price. A positive variance between the opening and closing material balances of a fiscal year is known as a layer for LIFO valuation. The layer is valuated as a seperated item. The total of a material is the sum of all layers.
A layer is dissolved if there is a negative difference between the opening and closing stock balances at the end of a fiscal year. This would happen, e.g, if all the new stock was consumed plus some of the existing stock.