Why lifo is advantage

As a result, the chances of future markdowns of inventory are reduced. As a result, both revenue and costs are recorded with the most recent values. Difficult reporting — If you have high inventory turnover, with prices that rise and fall over time, then your stock valuation will not reflect the prices that you actually paid. As a result, your procurement and merchandising teams will never know exactly how much money you have held up in inventory.

Non-correspondence with normal physical flow of inventory — All produced or purchased items are typically used first, like in FIFO, but LIFO takes the opposite approach that may not suit specific industries, such as those who work with perishable goods.

Reduced profits — Although reduced profits in the income statements can help reduce taxes, they can be a drawback in cases when, for example. Low figures in the income statements can present the company as a low performer and thus less attractive for potential investors. Profits depend on accounting periods — Due to inflation, most inventory is procured at the beginning of accounting periods.

As a result, the procurement activities should be shifted towards the end of the period for better profits. But such an approach will not suit all businesses, like those that sell seasonal goods. Adam Shrum. In some situations, the physical flow of inventory corresponds to the LIFO cost flow. For example, in the case of a coal pile, the most recent coal added to the coal pile is always on the top of the coal pile.

Therefore, the last coal in is always the first coal out. This benefit is not a reason of the popularity of LIFO method because the situations where physical flow of inventory corresponds to the LIFO cost flow are very rare to find. The benefit 1, 2 and 3 described above are the main arguments of the widespread employment of this method. The LIFO method reduces reported earnings during the periods of inflation.

Under LIFO method, the balance sheet inventory figure is usually understated because it is based on the oldest costs.

Due to understatement of inventory, the working capital position may look worse than it really is. The LIFO liquidation may inflate the reported income for a given period that results in higher tax payments for the period.

Under FIFO, the oldest inventory cost is used to calculate cost of goods sold. Returning to our widgets, it is now assumed that you sold the higher-cost June widgets first. Most companies try to sell their oldest inventory first to reduce the risk of obsolescence and spoilage, so costs are generally more accurate. This can help the business with planning and forecasting.

During times of inflation, FIFO has the effect of increasing the value of remaining inventory and increasing net income. Showing large assets and income can help a company that's trying to lure in potential investors and lenders. As the LIFO method of valuation is followed so inventory that is purchased at last will be considered to be sold first, so the registers purchased on March 20 th should be included in cost first, then the registers purchased on March 5 th and so on.

Since the total units sold were only, 50 units of inventory purchased on Feb 15 th are to be taken in the cost of goods sold calculation. The remaining units are considered in the closing inventory, along with the oldest inventory that was purchased on February 1 st. Following is the Tabular representation of the Calculation of Cost of goods sold and Closing inventory as of March 31 st. When the LIFO method of inventory valuation is used, it means that the purchased products first remain in the store and become obsolete or very old.

Also, the valuation under the LIFO method makes the valuation of inventory very low because the cost of old inventory items is obviously less than the cost of new items manufactured or purchased in this inflating market. The LIFO method of valuation is mostly used by the companies that have a relatively large level of inventories like retailers, etc.

The inventories are values at the earlier costs that are obviously low, and the high costs of recent inventories are included in the calculation of the cost of goods sold.