Inventory Management Methods: FIFO vs LIFO

fifo and lifo accounting

The theory is based on the logic of selling those inventories which are first purchased. Therefore, companies issue materials and utilize the goods that are set at higher price first.

FIFO states that if the bakery sold 200 loaves on Wednesday, the COGS is $1 per loaf because that was the cost of each of the first loaves in inventory. The remaining unsold 350 televisions will be accounted for in “inventory”. The LIFO reserve is the amount by which a company’s taxable income has been deferred, as compared to the FIFO method. We are going to use one company as an example to demonstrate calculating the cost of goods sold with both FIFO and LIFO methods.

How to Value Inventory: FIFO, LIFO, or Average?

The situation generally emerges from the contraction of the money supply in the economy. Inventory Write-downsInventory Write-Down refers to decreasing the value of an inventory due to economic or valuation reasons. When the inventory loses some of its value due to damaged or stolen goods, the management devalues it & reduces the reported value from the Balance Sheet. FIFO is not a suitable method if there is a high fluctuation in material prices. In an inflationary economy, using LIFO leads to lower profit figures and helps in tax savings, while using FIFO leads to higher profit and a huge tax burden. It is easy to use, generally accepted and trusted, and it follows the natural physical flow of inventory.

What is FIFO accounting method?

What is the FIFO method? FIFO stands for first in, first out, an easy-to-understand inventory valuation method that assumes that goods purchased or produced first are sold first. In theory, this means the oldest inventory gets shipped out to customers before newer inventory.

Keep your accounting simple by using the FIFO method of accounting, and discuss your company’s regulatory and tax issues with a CPA. The result is that the reported inventory asset balance has no relation to the cost of goods at current prices. For this reason, many companies choose to use a weighted-average cost method or use the current market price, how to calculate fifo and lifo also known as replacement cost, to prevent these types of issues. Some accountants in the US often advise using the LIFO method for your inventory accounting when you have stock with frequently changing costs. Using LIFO as a preferred method for such scenarios helps match the latest cost of inventory with the sales revenue of the current period.

LIFO vs FIFO Pros and Cons

Lastly, under LIFO, financial statements are much more easier to manipulate. It’s important to note that LIFO and LIFO accounting are not treated equally outside of the United States. LIFO is only permitted within the United States, so most companies using LIFO in their American operations will switch to FIFO when accounting for their international operations.

Why would a company use FIFO instead of LIFO?

A company may use FIFO instead of LIFO if it wants to show a more accurate inventory amount. If a company uses FIFO, they will be able to find the correct amount of its cost of production or acquisition and accurately record that number as the cost of goods sold.

Presently, LIFO is hardly practiced by businesses since inventories are rarely sold, it makes it difficult for inventory costing methods. Inventory accounting is only one part of a company’s management of its inventory investment, but an important one. For reporting purposes, FIFO assumes that assets with the oldest costs are included in the income statement’s cost of goods sold . So, if you sell a product, the cost of goods sold by using the FIFO method is the value of the oldest inventory. Valuating inventory equations is a process through which companies or businesses offer monetary inventory value for their commodities and generate accurate financial statements. In this article, we’ve explained each inventory valuation method in detail with examples.