Difference Between LIFO and FIFO

Edited by Diffzy | Updated on: September 24, 2022

       

Difference Between LIFO and FIFO Difference Between LIFO and FIFO

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Introduction

Various accounting procedures, such as LIFO and FIFO, are employed in corporate activities at the end of the financial year to determine the value of closing inventories, cost of goods sold, and stock repurchase. LIFO and FIFO's acronyms stand for Last In First Out and First In First Out, respectively. The Last-In, First-Out (LIFO) technique posits that the most current or most recent unit in inventory gets sold first. According to the First-In, First-Out (FIFO) system, the oldest merchandise branch is sold first. Many businesses cannot use LIFO because they cannot afford to keep more aged inventory in stock. Because organizations often employ their oldest list first in manufacturing their goods, FIFO is the most obvious option.

LIFO (last in, first out) is a methodology of inventory management in which the product or material received last is used first, and the stock in hand is made up of the first consignment. FIFO, on either hand, is a technique of inventory management in which the material acquired first is used first, i.e., items are issued from the earliest lot, and stock in hand is made up of the most recent lot. For companies that are fully stock-oriented, inventory management is a complex undertaking. Inventory management employs a variety of techniques. Some approaches are LIFO, FIFO, Simple Average, Base Stock, and Weighted Average. The method used to value inventory impacts the company's income, profitability, taxation, and other related aspects. Therefore, companies most typically utilize LIFO and FIFO methods.

LIFO Vs. FIFO

The critical distinction between LIFO and FIFO is that LIFO refers to when the most recently added goods are sold first. First In First Out, or FIFO, stands for the most recently added products to the stock that has yet to be sold. The accounting technique for the store is known as Last In First Out (LIFO). The Generally Accepted Accounting Principles (GAAP) govern the LIFO approach, widely popular in the United States (GAAP). The price of the most recently purchased things is first considered in this strategy. The accounting principle of First In First Out (FIFO) states that the assets or items acquired first are disposed of first. This strategy assumes that the remaining stock comprises the items purchased last. A small number of accounts are maintained using FIFO.

A company's inventory cost accounting technique can directly impact its primary financial statements (financials)—balance sheet, income statement, and statement of cash flows. Businesses can employ one of three inventory accounting systems under the US generally accepted accounting standards (GAAP): first-in, first-out (FIFO), last-in, first-out (LIFO), or average cost.

Difference Between LIFO and FIFO in Tabular Form

Table: LIFO Vs. FIFO
Parameters Of Comparison
LIFO
FIFO
Significance
LIFO (last in, first out) is a share price system in which the most recently purchased stock is issued first.
FIFO (First In, First Out) is a commodity method of valuation in which the first purchased inventory of products is issued first.
Evaluation
IFRS does not suggest the use of LIFO for stock valuation in accounting.
IFRS recommend
s the use of FIFO for stock valuation in accounting.
Inventory Currently Offered
It is the oldest supply of merchandise.
It represents the most recent inventory.
Current Market Value
The cost of products sold indicates the current market price.
The cost of unsold items indicates the current market price.
Inflation's Effects
When inflation is in the economy, the income tax shows the smallest amount feasible.
In an inflationary environment, income tax is high.
Deceleration
.
A significant amount of income tax is seen in a deflationary environment.
Reduction in income tax is seen in a deflationary economy
Known For
It means "first in, first out.
Last one in, first one out
Unsellable Inventory
Unsold inventory includes items purchased lately.
The earliest acquired commodities are included in unsold inventories.
Limitations
Using FIFO is not restricted by GAAP or IFRS; both enable this accounting method to be utilized.
LIFO accounting is not permitted under IFRS.
Higher Income Tax
Unsold inventory has a higher value.
When costs rise, newly purchased products become more expensive.
Inflation's Impact
If prices rise, the first products purchased will be the cheapest.
Under FIFO, this lowers the cost of goods sold (COGS) and increases profit.

What Is LIFO?

LIFO  stands for Last In First Out. It is an inventory costing approach in which the last items in an inventory are sold first. The initial items in the inventory are still in the inventory at the end of the year. As a result, this inventory valuation method is considered the most relevant and rational. As a result, most business people use it to keep track of their inventories. However, if the items are perishable, they will become obsolete quickly; therefore, it is preferable to handle the oldest stock first, reducing the risk of obsolescence. As a result, the remaining stock in hand will eventually display the most current inventory at the current market price.

When prices decline, the approach is deemed the best because the cost of production is higher than the cost of replacement. However, when prices are high, the situation is reversed, and it is difficult to order the same quantity of materials without having sufficient finances. In the United States, LIFO is only lawful and permitted under Generally Accepted Accounting Principles (GAAP). In the United States, all businesses adhere to GAAP. LIFO is not allowed in countries other than the United States, such as India, Russia, and Canada, which adopt the International Financial Reporting Standards (IFRS).LIFO is particularly profitable for American businesses since it helps them lower their tax burden; as a result, it is frequently employed in the US. Bookkeeping is complicated and complex under this method. It may also fail to reflect the company's actual cost. A corporation that sells marine items,

Example Of LIFO

Would not use their recently acquired inventory to sell and ship their products initially. In other words, the seafood company would never keep its oldest inventory sitting idle because the food could decay and result in losses. As a result, LIFO is inconvenient for many businesses that offer perishable commodities, and it fails to represent the natural production process of utilizing the oldest inventory first.

Inflationary Impact on LIFO

When employing the LIFO approach to record sales, the most recent inventory items are used to value COGS and are sold first. In other words, the older, less expensive goods would be sold later. As a result, the current COGS would be higher under LIFO in an inflationary environment because the new inventory would be more expensive. As a result, the company's profits or net income for the period would be reduced. However, the corporation will have a lower tax liability because of the lesser profit or earnings.

The last-in-first-out (LIFO) approach has the following advantages:

LIFO is widely used in businesses throughout the world because of the following advantages:

  •  LIFO compares most recent expenses to most recent revenues: The LIFO method compares most recent costs to most recent gains to better measure current earnings.
  • The main reason for the widely known last-in, first-out (LIFO) inventory valuation method is its tax benefit.
  • LIFO reduces write-downs to market: A company's net income is less likely to be affected by future price declines if it implements LIFO.
  • Inventory physical flow: In some cases, inventory physical flow correlates to the LIFO cost flow.

Last-in, first-out (LIFO) technique disadvantages:

The following are the key disadvantages of utilizing LIFO as an inventory costing method:

  • Inflationary periods mean lower earnings: The LIFO mechanism affects reported earnings during inflationary periods.
  • Inventory understatement: Because the LIFO approach is based on the oldest costs, the balance sheet inventory value is frequently understated.
  • LIFO Liquidation Issues: The LIFO liquidation may inflate a period's reported income, resulting in increased tax payments.
  • Manipulation of income: By modifying its buying pattern at the end of the year, a corporation adopting the last-in, first-out (LIFO) approach can easily manipulate its reported earnings for a period.

What Is FIFO?

FIFO stands for First in, first out is an asset management approach in which the actual issuance or sale of products from stores is made from the oldest lot on hand. It disposes of items in chronological sequence, starting with the thing placed in the inventory initially. As a result, this inventory valuation method is considered the most relevant and rational. As a result, most business people use it to keep track of their inventories. If the items are perishable, they will become obsolete quickly; therefore, it is preferable to handle the oldest stock first, which reduces the danger of obsolescence. As a result, the remaining stock in hand will eventually display the most current inventory at the current market price.

When prices decline, the approach is deemed the best because the cost of production is higher than the cost of replacement. However, when prices are high, the situation is reversed, and it is difficult to order the same quantity of materials without having sufficient finances. FIFO is a global accounting standard that follows the International Financial Reporting Standards (IFRS). The cost of products sold is determined by multiplying the price of the oldest inventory by the amount of merchandise sold following the FIFO method.

Benefits of the FIFO Method

The system has the following benefits:

  •  It is predicated on the reasonable premise that materials are distributed in the order that receipts are lost.
  •  Materials are given at actual cost, so there is no fictitious advantage or gain from using this method.
  •  This strategy is straightforward to comprehend and implement.
  •  The closing stock value will represent the current market.
  • If the number of purchases is small and the price of materials remains consistent. The procedure will be straightforward to use.
  • When prices are declining, this strategy is effective.
  • It is a logical method since it considers the standard procedure of using materials in the order they are obtained.

FIFO Method Advantages

The following are the benefits of the system:

  •  It is predicated on the reasonable premise that materials are distributed in the order in which receipts are lost.
  • Materials are given at actual cost, resulting in no unrealistic profit.
  • The strategy is straightforward to comprehend and use.
  • The closing stock value will be based on current market conditions.
  • If the number of purchases is low and material prices are consistent. It will be straightforward to use the method.
  • When prices are declining, this strategy is quite effective.
  •  It is a logical method since it considers the standard procedure of using things in the order in which they are obtained.

The Profit Impact of the FIFO Method

The profit is unaffected by the cost overstatement because the understatement in closing stock value compensates for it, and vice versa. However, because an increase or fall in material costs distorts the manufacturing cost of a particular product or task, profit on that product or job will likewise fall or rise.

Main Differences Between LIFO And FIFO in Points

The following points clarify the critical distinctions between LIFO and FIFO inventory valuation methods:

  • LIFO is a stock valuation method in which the last received lot in hand is issued first. FIFO, also called First In, First Out, means that the inventory generated or purchased first is disposed of or sold first.
  • The stock in hand in LIFO represents the oldest stock, whereas the stock in hand in FIFO represents the most recent products.
  • The cost of goods sold (COGS) in LIFO represents current market pricing, whereas the cost of unsold stock in FIFO represents the current market price.
  • According to the International Financial Reporting Framework, the LIFO approach is not permitted for inventory valuation, although the FIFO method is.
  • When the country's economy is experiencing inflation, LIFO will display a correct profit and assist in tax savings. In FIFO, however, the situation is precisely the opposite.
  • In contrast to LIFO, FIFO only keeps a small number of records.
  • FRS restricts corporations from using LIFO during the preparation of financial accounts, but IFRS enables companies to utilize FIFO.
  • The balance sheet favors LIFO over FIFO. This is because the number of records kept in LIFO reduces over time while the number observed in FIFO grows.
  • In the United States, LIFO is generally used, but FIFO is widely used in all other countries.

Conclusion

LIFO and FIFO both have advantages and disadvantages. When product prices rise, LIFO does not exaggerate earnings, but this strategy has some drawbacks. LIFO is no longer employed due to irrational assumptions, as it treats the most current stock in hand first, which is unjust because the most recent store is first in line. FIFO is a simple concept to grasp and implement. When there is a price drop, it provides the right image.

On the other hand, LIFO, FIFO, or average cost can be complicated. Therefore, knowing how to handle inventory is a crucial tool for businesses of all sizes and a critical success component for any company that keeps stock. For example, inventory management can assist a corporation in controlling and forecasting its earnings. In contrast, a company's inability to use inventory effectively might prevent operating efficiently.


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"Difference Between LIFO and FIFO." Diffzy.com, 2022. Fri. 09 Dec. 2022. <https://www.diffzy.com/article/difference-between-lifo-and-fifo-343>.



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