FIFO or LIFO?

Lesson:

LIFO (last in, first out) and FIFO (first in, first out) are two methods of measuring inventory value.

For many companies, it's incredibly important to know how much their inventory is worth. These inventories are assets that can be used to generate profits.

But, it's often difficult to track each and every piece of inventory. Pretend that you own a company that has an inventory of millions of plastic straws. It would be nearly impossible (and extremely expensive) to figure out what a particular straw cost to purchase.

So accountants engage in a little fiction. If they have a lot of identical goods, they will just say, "Oh, I bought a unit for $35, and I'll just pretend that the one in my hand was the one."

The question is, should they pretend that the unit that is about to be sold was one of the firm's earliest remaining purchases (LIFO) or one its most recent (FIFO)?

There are advantages to each, as you will soon see.

You're the CFO for Pepper corp. and need to decide on an inventory method for your firm.

You've been briefed with the following facts:

  • The company is preparing to go public and sell a very large block of shares.
Which would be more advantageous, LIFO or FIFO?

Answer:

  • The firm should use FIFO.

Explanation:

    For most businesses, the cost of newer inventory is much higher than the cost of older inventory. This means that most companies will look more profitable using FIFO.
    PROFIT = CUSTOMER PAYMENT - INVENTORY AND OTHER COSTS
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