What are FIFO and LIFO
In any organization, valuation of inventory is one of the most important jobs. True valuation of inventory helps to present the financial position of an organization at a fair and true value. A number of methods are available which helps to find out the value of inventory. In these FIFO and LIFO are the most effective and efficient methods.
FIFO stands for ‘first in first out’ method. In this method it is assumed that the goods we buy first are the goods we sold first. So it is concluded that the inventory must consist of the value of our last purchases. FIFO method is considered as an effective method if used during inflation as it leads to low valuation of cost of goods sold and maximum valuation of profit. The method can clearly be explained with the help of an example.
X purchases goods on different dates out of which 100 goods are left as inventory.
Number of Goods
If FIFO method is used for inventory valuation it is obvious that the inventory must consist of value of goods bought at the starting of year. If out of the goods purchased, 700 goods are sold, the inventory would be valued at Rs 3.00. So value of the remaining 100 goods would be Rs 300 at Rs 3.00/good.
LIFO stands for last in first out method. Under this method the assumption is taken that the goods we bought at last are the goods we sold first so it is obvious that the closing stock must consist of the value of goods which are purchased at the beginning of year. It is analyzed that if LIFO method is used at the times of inflation it would lead to high valuation of cost of goods sold and profit is evaluated much less as compare to another method.
If in former example LIFO method is used it is obvious that the inventory must consist of the value of goods bought at the end of year at Rs 5.00. The value of inventory would be RS 500.
It is clear that under FIFO method inventory is valuated at low rate as compared to LIFO method during the times when prices are rising.
There are number of methods available for inventory valuation. One must keep in mind the number of factors while opting for any method. It is necessary that once a method is opted’ the firm should stick to that method. This will help to reduce fluctuations in the valuation of inventory.