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Wednesday, December 3, 2014

FIFO vs. LIFO 12-03


FIFO vs. LIFO




FIFO and LIFO accounting methods are used for determining the value of unsold inventory, the cost of goods sold and other transactions like stock repurchases that need to be reported at the end of the accounting period. FIFO stands for First In, First Out, which means the goods that are unsold are the ones that were most recently added to the inventory. Conversely, LIFO is Last In, First Out, which means goods most recently added to the inventory are sold first so the unsold goods are ones that were added to the inventory the earliest. LIFO accounting is not permitted by the IFRS standards so it is less popular. It does, however, allow the inventory valuation to be lower in inflationary times.

Comparison chart







FIFO

LIFO

Stands forFirst in, first outLast in, first out
Unsold inventoryUnsold inventory comprises goods acquired most recently.Unsold inventory comprises the earliest acquired goods.
RestrictionsThere are no GAAP or IFRSrestrictions for using FIFO; both allow this accounting method to be used.IFRS does not allow using LIFO for accounting.
Effect of InflationIf costs are increasing, the items acquired first were cheaper. This decreases the cost of goods sold (COGS) under FIFO and increases profit. The income tax is larger. Value of unsold inventory is also higher.If costs are increasing, then recently acquired items are more expensive. This increases the cost of goods sold (COGS) under LIFO and decreases the net profit. The income tax is smaller. Value of unsold inventory is lower.
Effect of DeflationConverse to the inflation scenario, accounting profit (and therefore tax) is lower using FIFO in a deflationary period. Value of unsold inventory, is lower.Using LIFO for a deflationary period results in both accounting profit and value of unsold inventory being higher.
Record keepingSince oldest items are sold first, the number of records to be maintained decreases.Since newest items are sold first, the oldest items may remain in the inventory for many years. This increases the number of records to be maintained.
FluctuationsOnly the newest items remain in the inventory and the cost is more recent. Hence, there is no unusual increase or decrease in cost of goods sold.Goods from number of years ago may remain in the inventory. Selling them may result in reporting unusual increase or decrease in cost of goods.
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