FIFO and LIFO Methods of Inventory
FIFO (first-in, first-out) and LIFO (last-in, first-out) are the most common inventory valuation approaches used by business enterprises to account for the value of items sold.
FIFO: This approach involves accounting for the value of inventory a company receives first when items are sold. It is a simplified method where a business owner accounts for the first incoming inventory as the first sales made. It can be used by businesses to track value of items in stock easily.
LIFO: This approach involves accounting for the most newly received inventory with first sales made. It gives a clear picture of the current market prices of the items sold shortly upon being received by the business owner. It can be used to maintain a low taxable income if the economy is experiencing inflation, since the recent purchases are probably higher.
Various businesses have different approaches of accounting for their inventory, but it is fine to choose an ideal method suitable for your business. However, these valuation approaches have their own advantages and disadvantages to small businesses. Depending on the financial implications and outcomes, you need to identify the strategic benefit that a given approach will bring to the business.
Therefore, let us look at the advantages and disadvantages of both FIFO and LIFO to small businesses.
Advantage and Disadvantages of FIFO
The approach is used to account for the value of inventory received first after sales have been made.
- It is a straightforward method because business owner accounts for the first inventory received, as the first sale of items is made
- If you need an approach to help in tracking your inventory goods, FIFO is the option to choose.
- Higher taxable income during inflation periods, because initial inventory costs are less
- It may be difficult to track varying quantities of inventory items that were bought at different times
- Might be difficult to account for costs of returned inventory or exchanged inventory
Advantage and Disadvantage of LIFO
The approach is used to account for the most recent inventory received with first goods sold.
- It shows clear market costs of the inventory sold shortly upon receiving
- Help keep the taxable income low, especially during inflation periods because the prices of the recently bought items are typically higher
- Difficult to account the exact value of the inventory based on the current market prices, making it hard to construe the company’s current operating activities and the inventory activities
- Difficult to switch to FIFO, until IRS approves your request to do so