LIFO method is like any store where the clerks stock the last item from front and customers purchase items from front itself. This means that inventory located at the back is never bought and therefore remains in the store. Presently, LIFO is hardly practiced by businesses since inventories are rarely sold, it makes it difficult for inventory costing methods. Therefore the commodities at the end of inventory layers become old and gradually lose their value.
Oldest inventory will always be held back the end of the list. These generally accepted accounting procedures use for accounting purposes help to keep an eye the current market prices and manage helps in manage the remaining balance sheet value. It also makes various warehouse operations easy.
The only reason for using LIFO is when companies assume that inventory costing methods and the higher inventory cost themselves will increase over time providing a higher value, which means prices will inflate.
This means higher earnings for the company. While implementing LIFO system, cost of inventories at the end of inventory face price increases, as compared to inventories, purchased earlier. Due to the rising prices of already present inventory items this becomes a little complex.
Increasing unit costs affect sales price. It makes fundamental analysis of higher cost items difficult in the recent inventory turnover.
Inventory purchases month units are added to the existing inventory. This makes it easy to calculate gross profit, average cost method and the product unit cos t.
It also reduces high income tax expense. This causes higher cost items to be sold gaining higher profit. As a result, the ending inventory balance is valued at previous costs whereas the most recent costs appear in the cost of goods sold. Larger ending inventory unit cost value causes complications in goods calculation, which affects the current financial health and net profit of the company. Using LIFO on the following information to calculate the value of ending inventory and the total cost of goods sold as for the accounting period of March.
FIFO First-in, first-out method is based on the perception that the first inventories purchased are the first ones to be sold. It is a cost flow assumption for most companies. Since the theory perfectly matches the accounting principles and the actual flow of goods, therefore it is considered as the right way to value dynamic inventory.
Also, it is more logical approach, as oldest goods get sold first, thereby reducing the risk of getting obsolete. For investors, inventory can be one of the most important items to analyze because it can provide insight into what's happening with a company's core business.
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Table of Contents Expand. What Is Inventory? LIFO vs. Under LIFO, firms can save on taxes as well as better match their revenue to their latest costs when prices are rising. American Institute of Certified Public Accountants. Internal Revenue Service.
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Search for software and business topics:. Advertiser Disclosure. LIFO vs. Mary Girsch-Bock Accounting Specialist. What is LIFO? The LIFO method assumes the last items placed in inventory are the first sold. What is FIFO? FIFO: What's the difference? While in most cases, FIFO is the better option, LIFO can be used for the following reasons: Better matching of product cost with revenue: By selling newer inventory products first, the cost will be better matched with revenue.
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