FIFO Vs. LIFO What Are the Different Essay

FIFO vs. LIFO

What are the different methods of inventory valuation?

Inventory valuation is a very important component to company financial statements. For one, capital intensive companies tend to have higher levels of inventory due to their overall business operations. Manufacturing company's, for instance may have large inventory holdings as goods are classified into "finished goods inventory," or "partial inventory." Retail companies also tend to have large amounts of inventory to cater to their respective customer demographics and markets. As such, differing valuation methods are needed in order to effectively ascertain inventory levels. Inventories, in regards to financial statement reporting, are usually the largest current asset of a business. Therefore, proper measurement is needed to insure an accurate account of value. For example, in the occurrence that inventory is not properly accounted for, revenues and expenses will be misaligned causing misguided decision making (Jonathan, 1995).

To begin, there are two distinct accounting systems used to value inventory. These systems are called perpetual inventory, and periodic inventory. Perpetual inventory provide accounting records that indicate the amount of inventory on hand at all times. The system is updated every time an item is bought or returned. Likewise, there is also the periodic inventory system, which records sales but not inventory changes. As such, a physical inventory is taken at the end of each year or period. This method is preferred by many small businesses will low physical inventory counts. In many of these instances, the small business relies primarily on intangible assets rather than fixed assets with inventory.

In regards to inventory valuation there are three widely used concepts.The first is FIFO. Under the first-in, first out method, inventory that is the oldest are recorded as the first sold. The second is LIFO. Under the last-in, first-out method, the most recently produced items are sold first. Companies use this method particularly in inflationary periods to lower income taxes. Finally, the third method is the weighted average cost method. This method calculates the cost of goods available for sale and divides the amount by the beginning inventory and purchases.

How would a company decide which method is most appropriate for their company? Please discussion the various factors that would play a role in this decision.

Business is varied across different industries. As such, differing account metrics are needed to reflect the underlying business operations of a firm. These underlying business factors are what help determine which inventory valuation method will be used. In the instance of the LIFO method, this would be used if the company sales it's most recent items first. An example would include a DVD store which will often sell its new releases before it sales its older ones. This also occurs with bookstores who often sell the latest copies of a bestselling book before them sale older copies. Also the inventory system used can also help determine the most appropriate method used by the company. Under a perpetual system, as mentioned above, companies track the cost of goods for every transaction. When a company values the inventory on one specific date under the periodic system, those costs are synthesized together. As such only the end of period….....