FIFO vs. LIFO What Are the Different

FIFO vs. LIFO What are the different methods of inventory valuation? Inventory valuation is a very important component to company financial statements. For one, capital intensive companies tend to have higher levels of inventory due to their overall business operations. Manufacturing company's, for instance may have large inventory holdings as goods are classified into "finished goods inventory," or "partial inventory." Retail companies also tend to have large amounts of inventory to cater to their respective customer demographics and markets.

As such, differing valuation methods are needed in order to effectively ascertain inventory levels. Inventories, in regards to financial statement reporting, are usually the largest current asset of a business. Therefore, proper measurement is needed to insure an accurate account of value. For example, in the occurrence that inventory is not properly accounted for, revenues and expenses will be misaligned causing misguided decision making (Jonathan, 1995). To begin, there are two distinct accounting systems used to value inventory. These systems are called perpetual inventory, and periodic inventory.

Perpetual inventory provide accounting records that indicate the amount of inventory on hand at all times. The system is updated every time an item is bought or returned. Likewise, there is also the periodic inventory system, which records sales but not inventory changes. As such, a physical inventory is taken at the end of each year or period. This method is preferred by many small businesses will low physical inventory counts. In many of these instances, the small business relies primarily on intangible assets rather than fixed assets with inventory.

In regards to inventory valuation there are three widely used concepts. The first is FIFO. Under the first-in, first out method, inventory that is the oldest are recorded as the first sold. The second is LIFO. Under the last-in, first-out method, the most recently produced items are sold first. Companies use this method particularly in inflationary periods to lower income taxes. Finally, the third method is the weighted average cost method.

This method calculates the cost of goods available for sale and divides the amount by the beginning inventory and purchases. How would a company decide which method is most appropriate for their company? Please discussion the various factors that would play a role in this decision. Business is varied across different industries. As such, differing account metrics are needed to reflect the underlying business operations of a firm. These underlying business factors are what help determine which inventory valuation method will be used.

In the instance of the LIFO method, this would be used if the company sales it's most recent items first. An example would include a DVD store which will often sell its new releases before it sales its older ones. This also occurs with bookstores who often sell the latest copies of a bestselling book before them sale older copies. Also the inventory system used can also help determine the most appropriate method used by the company.

Under a perpetual system, as mentioned above, companies track the cost of goods for every transaction. When a company values the inventory on one specific date under the periodic system, those costs are synthesized together. As such only the end of period data will be included. Under each system the value of inventory would be different. If management wants to lower the value of inventory, then one method would be preferred over the other. In addition the LIFO method is preferred during periods of rising inflation or increasing prices.

Under LIFO, cost of goods sold would be the inflated resulting in a lower taxable income. A lower taxable income results in a lower income tax. Therefore companies with tax consideration may consider the LIFO method (Gibson, 2002). FIFO is the preferred method of companies with products with limited life or use. This method is preferred for grocery store chains as products often have a predetermined shelf life. Technology companies are using this method as innovations create products which quickly become obsolete.

This method also provides consistency in regards to accounting as inventory is always measured in the most current costs. Finally, the average cost method works well with companies with vary large amounts of identical products. These products may include steel bars, or widgets. The sheer amount of inventory makes it very difficult for management to determine the cost of each small widget. However, by assigning an average cost to the identical items, each unit is treated the same.

This method is preferred for companies who desire ease of calculation and have very similar product inventory (Saxena, 2009). Log into the FASB Codification and access the FASB Statements of Financial Accounting Concepts. Address the following items: Which concept statement addresses present value measurement in accounting? Concept statement number 7 addresses the concept of present value measurements. Financial reporting is often based on management assumptions about the future, relative to performance of the past. Paragraph 41 addresses specifically the concept of present value measurements in regards to fair value.

As the concept statement indicates, measurement of PV should include estimation of future cash flow and interest rates. These rates, in.