Using LIFO typically lowers net income but is tax advantageous when prices are rising. The use of LIFO when prices rise results in a lower taxable income because the last inventory purchased had a higher price and results in a larger deduction. Conversely, the use of FIFO when prices increase results in a higher taxable income because the first inventory purchased will have the lowest price. It can also result in inventory valuations that are outdated and obsolete.
Under LIFO, firms can save on taxes as well as better match their revenue to their latest costs when prices are rising. The LIFO valuation method assumes that the last inventory item purchased is the first one used in production or sale. This means that the net income and ending balance amounts are lower under the LIFO method. However, when prices are falling, the LIFO method is likely to generate higher net income. Here is an example of LIFO inventory accounting.
This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Read More. Table of Contents. What are some examples of evidence? How do you cite a website at the end of a paper?
Inventory is the goods and products a business sells to customers. Depending on the particular economic environment, LIFO may result in lower or higher earnings compared to other methods. A company assigns the cost of the inventory it sells during an accounting period to a type of expense account called cost of goods sold.
With all else being equal, a higher cost of goods sold results in lower net income than a lower cost of goods sold.
A company may pay different costs at different times to purchase the same inventory. The LIFO method assumes a company sells the inventory it purchased most recently before selling older inventory. Using this method, a company assigns the cost of its newest inventory to cost of goods sold before assigning the cost of its older inventory.
As the tank is refilled, the new gasoline mixes with the old. Thus, any amount used is a blend of the old gas with the new. In fact, good reasons exist for simply ignoring physical flows and choosing an inventory method based on other criteria.
Advantages and disadvantages of specific identification Companies that use the specific identification method of inventory costing state their cost of goods sold and ending inventory at the actual cost of specific units sold and on hand. Some accountants argue that this method provides the most precise matching of costs and revenues and is, therefore, the most theoretically sound method. This statement is true for some one-of-a-kind items, such as autos or real estate. For these items, use of any other method would seem illogical.
One disadvantage of the specific identification method is that it permits the manipulation of income. For example, assume that a company bought three identical units of a given product at different prices. The units are alike, so the customer does not care which of the identical units the company ships. Which is the correct method? All four methods of inventory costing are acceptable; no single method is the only correct method.
Different methods are attractive under different conditions. If a company wants to match sales revenue with current cost of goods sold, it would use LIFO. If a company seeks to reduce its income taxes in a period of rising prices, it would also use LIFO. On the other hand, LIFO often charges against revenues the cost of goods not actually sold. Also, LIFO may allow the company to manipulate net income by changing the timing of additional purchases.
The FIFO and specific identification methods result in a more precise matching of historical cost with revenue. However, FIFO can give rise to paper profits, while specific identification can give rise to income manipulation. The weighted-average method also allows manipulation of income.
Only under FIFO is the manipulation of net income not possible. Generally, companies use the inventory method that best fits their individual circumstances. However, this freedom of choice does not include changing inventory methods every year or so, especially if the goal is to report higher income.
0コメント