The two most commonly used techniques for the valuation of inventory are the FIFO and LIFO methods of accounting. The difference between the two is simple, no doubt, but the fact remains that your choice will have serious implications on your business. Bearing this in mind, here is an account of these two methods of inventory valuation and when they should be employed:
FIFO stands for “first-in, first-out”. What this means is that when you end up making a sale, you account for the value of inventory that was received first. The company will assume that the items it purchased or manufactured first are the items that it sold first as well. When you take things into perspective, the usage of the FIFO method of accounting appears to offer a more natural approach to doing things, owing to how it presents a straight-line approach for keeping track of inventory and sales. Ultimately, the usage of FIFO accounting simplifies the accounting required for tracking of items in the inventory.
LIFO stands for “last-in, first-out”. In contrast to the FIFO method of accounting, LIFO method means to account for the value of inventory that was received last, when you end up making a sale. Or, in other words, the LIFO method of accounting assumes that the most recently received inventory items are the first to have been sold. When you take things into perspective, the LIFO method of accounting appears to give a much more realistic picture of things, considering how companies sell their inventory items shortly after they have been purchased.
Need To Make things Easier? FIFO
As has already been discussed, FIFO helps in making the tracking of your inventory items easier. LIFO, on the other hand, causes a discrepancy in the reported and the actual numbers and prices, owing to how you are working back towards the inventory you had received earlier. What this means is that the accurate prediction of the company’s operating activities will be much more difficult. The case of modeling the company’s inventory activities would be similar.
Need To Reduce Tax? LIFO
When you speak of the LIFO method of accounting, it is quite understandable that it results in a lower tax liability, owing to how the company’s costs are overestimated. For those who don’t know, the company’s costs are estimated because the last purchased item is assumed to be sold first, owing to how the recent purchases usually have higher prices, especially in times of inflation. FIFO accounting, on the other hand, underestimates your cost of goods sold, meaning that your profits are, ultimately, overstated. And you know what overstated profits mean, right? You owe more tax to the state!
When you take the differences into consideration, there are multiple considerations that need to be made, when choosing the best accounting system for your company. This can be a difficult job, which the financial experts at SKB Accounting can make easier, as well as more streamlined, for you!