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Guide to the FIFO and LIFO accounting

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Guide to the FIFO and LIFO accounting Powered By Docstoc
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FIFO and LIFO accounting methods are designed to assess inventories and financial matters
involving funds associated with inventory of raw materials, components or goods produced.

When used as a method of LIFO inventory accounting, the company records the last units
purchased as the first that have been sold. LIFO is an acronym for last in, first out, and it is the
opposite of FIFO (first in, first out).

Based on the principle that the prices of things rise steadily with time due to inflation, this
method records the sale of inventory first with the more expensive, thus, reporting a lower profit
which reduces tax payable. However, this system does not reflect the physical flow of intangible
goods such as oil.

The LIFO accounting supports the belief that a steady business does not make profits only
through inflation. When prices rise, they must replace the inventory that is sold at higher prices -
better associated with LIFO replacement cost. LIFO is not accepted by the international
accounting standards, and is mostly used in the United States.

This method assumes that the next item to be sold is one that takes more time to be stored. In
an economy with rising prices, it is common for companies to use FIFO during inflation as an
initiative to increase the value of their assets. As the older and cheaper goods are sold, the
more new and expensive goods remain as assets of the company.

Having the most expensive inventory and cost of products sold low allows the company to show
better economic performance. However, as they grow, some companies prefer to change their
accounting system to LIFO inventory to reduce taxes.

Without taking into account the deferred tax benefit, the LIFO system can lead to liquidation, a
situation where the business does not replace the inventory sold or seeking to increase its
usefulness. If prices have been steadily growing, the old stock will have a lower cost, and its
payment will cause a higher turnover and thus pay more taxes.

Hence, nullifying the advantage of the tax burden that initially motivated the adoption of the last
in first out system. Some companies that use LIFO inventory have decade-old records on their
books at very low prices. For these companies, LIFO liquidation would result in inflated billing
and payment of tax. And should also take into account the ultimate method of revaluation of
existence which is the weighted average price.

				
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