FIFO and LIFO Inventory Methods
Accounting 211 – Financial Accounting
FIFO and LIFO Inventory Methods This paper will provide a comparison of the accounting implications of valuing inventory under the First-in, First-out (FIFO) and Last-in, First-out (LIFO) methods. With very few exceptions, every business depends on an inventory to operate. Whether the business provides a service or sells products to its consumers, supplies and stock are required to operate. In the complex process of business accounting, keeping track of inventories, cost of goods and unit pricing are vital to the company's success especially with price fluctuations of products the company purchases. Several methods are used to
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When inventory costs are rising, the LIFO method produces the highest cost of goods sold. This is due to the newest costs being utilized to compute the cost of goods sold. Subsequently, gross profit will be lower. This is particularly advantageous for tax reporting purposes since income tax expenses are computed using gross profit. In addition to lower gross profit, the ending inventory will also be lowered. When inventory costs are decreasing, the LIFO method produces a higher gross profit and ending inventory but also reports a lower cost of goods sold. Depending on how a company wants to report their gross profit and ending inventory, they may choose either method. While FIFO will traditionally offer up a higher gross profit, LIFO offers the benefits of a tax break. Currently both FIFO and LIFO are acceptable practices used under GAAP. However, the International Financial Reporting System (IFRS) prohibits companies from using LIFO (Deloitte, 2004). Since the IFRS is rapidly becoming the standard and will eventually replace GAAP in the United States, many companies are transitioning away from using LIFO.