FIFO is an abbreviation of First In, First Out. It is an asset-management and assessment method that recommends using, disposing or selling of those assets that are acquired or produced first while retaining those bought last. It is can be used by a person or corporation. On the other hand, LIFO is an acronym of Last In, First Out (Finkler, S. A. et al. 2013). It is an asset-management and valuation technique that recommends using, disposing or selling of those assets that are acquired or produced last while retaining those bought first. It is can be used by a person or corporation. This paper examines the advantages and disadvantages of FIFO and LIFO inventory methods and evaluates the best inventory method for this scenario.
Advantages of using FIFO for Inventory Management
Reduce Outdated Inventory – the outdated inventory refers to the inventory that is obsolete and outdated. Thus, the inventory is not appropriate for sale or use in creation. Numerous businesses necessitate that outdated stock written off against its bottom line after a scheduled period of time has lapsed subsequently to its last usage (Harris, P. et al. 2014). FIFO aids to prevent obsolete stock by the use of inventory that is received first before using newfangled inventory.
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Diminish Influence of Inflation – Inflation refers to the upsurge in price of stock over time. FIFO can aid to reduce the effect inflation in the company. Suppose inflation is constant, the acquisition price of the stock used in the creation or that sold at retail is lesser than the price of stock that is newly purchased (Murdoch, B. et al. 2013). Since direct materials expense is recorded at the purchase price of the used stock or sold, the cost is lower than if the existing market value of the objects is used to record the expenditure.
Current Ending Inventory Value – FIFO guarantees that the termination inventory standards on the balance sheet reflects the current market price of the stocks. The inventory on the books of accounts consists of recently purchased stock. Further, FIFO guarantees that the ending inventory on the balance sheet reflects contemporary market prices.
Disadvantages of using FIFO for Inventory Management
Clerical Errors – in a situation where there is a fluctuation in inventory prices it is cumbersome to appropriately record cost of goods, retailing prices of goods and any incongruity caused from rising and falling prices in the markets.
Inconsistent Prices – FIFO results to inconsistency prices offered to clients. The method is inappropriate particularly when the stock purchased during periods that have diverse prices. Thus, to avoid inconsistency LIFO is preferred generally.
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Advantages of using LIFO for Inventory Management
Minimizes write-downs to markets –LIFO minimizes deterioration in prices of goods due to inflation effects. The company sells the goods that it has purchased at a current price first (Murdoch, B. 2013). Thus, there is no expected loss due to inflation.
Tax benefits and improvement in cash flows – LIFO is efficient in reducing the payable tax to the government. The method ensures that the company reports lower profit. The lower profit often results to lower taxation rate.
Disadvantages of using LIFO for Inventory Management
Underestimation of Stock – The LIFO method belittles the inventory figure in the balance sheet as it is grounded on the older costs. Due to the underestimation of stock, the working capital position seems worse than the real situation.
Reduced Incomes in Inflationary Times – The technique diminishes stated earnings during the period of price rises. It will have negative results and scare away potential investors due to lessen prices of firm’s stock during inflation.
LIFO Liquidation Challenges – The LIFO method inflates the reported returns for a specific period resulting to higher tax expenditures for the period. To avoid the expenses, the company can buy goods in large quantities with the intent of matching them against proceeds. Consequently, the adoption of LIFO results to poor purchasing habits among firms.
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The paper has examined the advantages and disadvantages of FIFO and LIFO inventory methods and evaluate the best inventory method for this scenario. The FIFO method has a diminishing influence on inflation and reduced outdated inventory. The disadvantage of this method is that it results to clerical errors and inconsistency in prices. Further, the disadvantage of LIFO can be described as liquidation challenges, reduced incomes in inflationary times, and underestimate stocks. The paper recommends the use of FIFO so as to reduce cost resulting from expiration of medication.
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Finkler, S. A., Purtell, R. M., Calabrese, T. D., & Smith, D. L. (2013). Financial management for public, health, and not-for-profit organizations (4th ed.). Upper Saddle River, NJ: Pearson Prentice Hall.
Harris, P., Kinkela, K., Stahlin, W., & Washington, L. (2014, January). The Present and Future Outlook of the Last in First out Inventory Methods. In Global Conference on Business & Finance Proceedings (Vol. 9, No. 1, p. 183). Institute for Business & Finance Research.
Murdoch, B. (2013). Comparing LIFO and FIFO: An Empirical Test of Representational Faithfulness. Conflict Resolution & Negotiation Journal, 2013(1).
Murdoch, B., Dehning, B., & Krause, P. (2013). Further Evidence On The Ability Of FIFO And LIFO Earnings To Predict Operating Cash Flows: An Industry Specific Analysis. Journal of Applied Business Research (JABR), 29(4), 1231-1242.
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