LIFO vs FIFO acounting methods

LIFO vs. FIFO

LIFO vs. FIFO

LIFO and FIFO are both popular ways to calculate and keep track of inventory. LIFO means last in, first out and FIFO means first in, first out. The key difference to these two types of inventory tracking methods is the way they affect the cost of goods sold on the balance sheets.

Let's start with what exactly is inventory. Inventory is the physical assets of a company that are intended for sale or are in the process of being produced for a sale. Inventory is constantly changing due to items being sold or more being accumulated. It is very important on a company's financial statements because it represents most of the company's assets. The main reason for there being several different ways to calculate inventory is because of inflation. Inflation has continued to rise for the last forty years. It can affect the cost of inventory, the monthly statements, and even the cash flow. There is another method that can be used to track inventory known as average cost. This article will only be focusing on the LIFO and FIFO methods due to their popularity.

The first method is LIFO which uses both unit base and cost base methods of inventory valuation. This means that the last unit brought into the inventory is matched with the current sales revenue. The units that remain in the inventory are matched to the oldest units cost available. An example would be a pile of the coal. The coal at the bottom of the pile was purchased first but the coal on top that most recently purchased will get sold first.

This has been the most preferred method by companies since the 1970s. During this decade is when the United States experienced a major increase in inflation which it had continued to rise for the last forty years. Most people that adopted this method believe that the overall costs either increase or remain stable. The net income is lower while the cost of goods sold is higher. This method is mostly used with companies that have very large inventories. They prefer this method because they can receive tax deductions. On the other hand their balance sheets are not as appealing due to the high inventory prices. This could affect future loans and attracting future business partners.

FIFO is the cost of units sold during an allotted time that reflect the oldest inventory cost just before the sale. The remaining inventory then reflects the current or replacement cost. This method works best when the economy has stable prices. Most companies that use this method want to continually move their stock in order to prevent the deterioration of it and many times they ship identical items. This method is appealing to companies that deal with a lot of perishable items. A good example of this method is when grocers restock milk they push the older milk towards the front of the shelves. Then they put the freshest milk behind the older milk in hopes of selling the older milk first. This method is most accurate for indicating the value of ending inventory. It also raises the net income which could cause a company to pay more in taxes. Another downfall to the FIFO method is that when inflation occurs the inventory actually shows a profit just by holding inventory. This is not the best for matching costs and revenues. A lot of smaller companies use the FIFO method because it shows the higher inventory on their financial statements. This could be used to their advantage by attracting more business, mergers, obtaining a loan, and increase the value of their stocks. Once companies experience significant growth they typically switch over to the LIFO method.

Companies can switch back and forth between the methods but it's not recommended due to the complexities and amount of work involved in switching from one method to the other method. A company could have the best of both worlds if they used LIFO for tax purposes and FIFO for their books. The IRS unfortunately requires a company that uses LIFO for tax purposes to also use it to track their books. It is still however legal to use FIFO for tax purposes and LIFO for tracking their books. Lenders are also aware of the different methods and often ask companies for their reasoning behind their decision to use a specific method. The decision of which inventory tracking method to use is crucial for any company because it affects some many other parts of the companies potential success. Consider all possibilities and see which method will benefit your company most by doing the research.

LIFO vs FIFO acounting methods

By: Marietta

POST COMMENT

They ambit from the simple on the attic rocker architecture HP HP0-Y25 dumps Kingside castling involves castling using the rook Nikola Tesla's Secret Can You Really Have It All? Is Being "Over Qualified" Blocking Your "Employed" Status Raise Capital with Private Placement Memorandum ANGRA DOS REIS NFL Latest Line Precio Del Oro En El Mercado Mundial Changes Mean Neighbour Agreements Can Now Be Bound By Law JN0-311 test dumps You Need to Feel Good No Matter What!