Accounting Methods
FIFO and LIFO Methods are accounting techniques used in managing inventory and financial matters involving the amount of money a company has tied up within inventory of produced goods, raw materials, parts, components, or feed stocks. These methods are used to manage assumptions of cost flows related to inventory , stock repurchases (if purchased at different prices), and various other accounting purposes.
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Inventory Template
Example of inventory template.
- FIFO stands for first-in, first-out, meaning that the oldest inventory items are recorded as sold first but do not necessarily mean that the exact oldest physical object has been tracked and sold.
- LIFO stands for last-in, first-out, meaning that the most recently produced items are recorded as sold first. Since the 1970s, some U.S. companies shifted towards the use of LIFO, which reduces their income taxes in times of inflation, but with International Financial Reporting Standards banning the use of LIFO, more companies have gone back to FIFO. LIFO is only used in Japan and the U.S.
In Periods of Rising Prices (Inflation)
- FIFO: (+) Higher value of inventory (-) Lower cost of goods sold
- LIFO: (-) Lower value of inventory (+) Higher cost of goods sold
In Periods of Falling Prices (Deflation)
- FIFO: (-) Lower value of inventory (+) Higher cost of goods sold
- LIFO: (+) Higher value on inventory (-) Lower cost on goods sold
Benefits of LIFO
LIFO considers the last unit arriving in inventory as the first one sold. Which method an accountant selects can have a significant effect on net income and book value and, in turn, on taxation. Using LIFO accounting for inventory, a company generally reports lower net income and lower book value, due to the effects of inflation. This generally results in lower taxation. Due to LIFO's potential to skew inventory value, UK GAAP and IAS have effectively banned LIFO inventory accounting.