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# FIFO _ LIFO

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```									       FIFO & LIFO
IB2 Higher Level
Recap
   What are the two methods of depreciation
   Straight line method, Reducing balance method
   What is a budget?
   A financial plan for expected revenue and
expenditure for an organisation or department for
a given period of time
   What is the formula for ARR
   Total profits ÷ number of years of project x 100
Amount invested (£)
Lesson objectives
   By the end of the lesson students should be
able to: -
   Understand the ways businesses value stock on
the balance sheet
   Know the term FIFO and LIFO
Stock valuation
   For many businesses, stocks (or inventories)
represent a significant proportion of assets so
must be accurately recorded on the balance
sheet.
   Stock valuation is the technique used to
measure the value of raw materials, work-in-
progress or finished goods.
   Stock valuation is important when stocks are
difficult to distinguish in terms of purchase
date and cost.
For example
   Crude oil prices change
on a daily basis
   It is difficult to
distinguish between
different batches of
stocks.
   This means a firm’s
inventories will consist
of different batches of
deliveries valued at
different purchase costs
Supermarkets
   In supermarkets it is difficult to distinguish
between different batches of the same product.
   Supermarkets use a stock rotation system
whereby the newest stocks go to the back of the
shelves to ensure the older batches are bought
first.
   This is particularly important for perishable
goods.
   There are two main methods of stock valuation
   LIFO Last In First Out
   FIFO First In First Out
Last In First Out
   This methods involves using the most recent
batches of stocks first.
   It is a suitable method for businesses that do not
need to adhere to a sell by date.
   The result is the older stock, which is usually valued
at a lower cost will remain the same. I.e. the closing
stock will be a lower value.
   Businesses that use LIFO tend to have big
inventories
   This will result in tax benefits as although there is no
fundamental difference in the business the gross
profit figure will be lower
LIFO Cont…
   Cost of goods sold = opening stock+ purchases-
closing stock

   Therefore a lower valued closing stock will mean a
higher cost of goods sold.

   Gross profit = Sales Revenue- COGS

   Therefore lower gross profit and subsequently lower
corporation tax payable
LIFO Cont…
Date    Stock        Stock        Stock      Stock valuation
bought       issued       left
1st     30 Units @                30 x \$25            \$750
\$25 p/u
March
5th                  20 Units @   10 x \$35            \$250
\$25 p/u
March
8th     20 Units @                10 @ \$25   \$250     \$850
\$30 p/u                   20 @ \$30   \$600
Match
10th                 15 units @   10 @ \$25   \$250
30 p/u       5 @ \$30    \$150
\$400
March
Table what it means!
   At the begging of March the form bought 30 units of
stock at \$25 each, therefore the stock valuation is \$750
   Four days later 20 units were needed for production, so
there was 10 units left, valued at \$250
   On 8th March the form paid the supplier for another 20
units, however they now cost \$30, giving a valuation of
600, which is then added to the \$20 giving \$850
   On 10th March 15 units are issued for production. LIFO
means all 15 units are values at \$30 (the most current
cost value). This leaves 5 left, \$150, added to the
unused batch of earlier stock, \$400
   The total value of stocks equals \$1350, \$750 on 1st
March and another \$600 on 8th March
First In First Out
   This is a method of stock valuation whereby stock is
valued based on the order in which it was
   This method ensures that any unsold stock is more
realistically valued as its current or replacement
stock is valued at the most recent purchase cost.
   It is suitable for business that regularly rotate their
stocks.
   On the balance sheet it is a more realistic and
representative of the current market value.
   It will boost the gross profit
FIFO Cont…
Date    Stock        Stock        Stock      Stock valuation
bought       issued       left
1st     30 Units @                30 x \$25            \$750
\$25 p/u
March
5th                  20 Units @   10 x \$35            \$250
\$25 p/u
March
8th     20 Units @                10 @ \$25   \$250     \$850
\$30 p/u                   20 @ \$30   \$600
Match
10th                 10@ 25 p/u 15 @ \$30     \$450
5 @ 30 p/u
\$450
March
Comparing…
   The closing stock values
   LIFO= \$400

   FIFO= \$450
   If revenue is \$1750. The impact on profits would be

LIFO               FIFO
Sales                      1750               1750
COGS
Purchases           1350               1350
Closing stock       400                450
950                900
Gross Profit               800                850
Choosing between LIFO and
FIFO
   If there were no price increases over time
LIFO and FIFO would get the same results,
however the reality prices increase due to
inflation.
   Laws are in place to stop firms switching
between FIFO and LIFO, the same has to be
used when account presented to the
government and the shareholders
   In UK and Canada LIFO is not permitted for
tax but it is in USA
    Using LIFO and FIFO construct a Profit
and Loss Account to show the effects on
the firm’s trading profit. The market price is
Month             Stocks         Cost p/u      Stocks       Value of
purchased (\$)                issued       stock
(units)                      (units)      purchased
January           1000           10              1000            10000

February 1000                    11              1000            11000

March             1000           12              1000            12000

Total             3000                                           33000

Opening stock in Jan = 1000 units at \$9000 each, giving a total of 4000 units in the
Given time period
Homework
    Crystal Arts is a producer of expensive chandeliers. Each
chandelier sells for £1000. During this month the firm has
taken orders for 15 chandeliers. It has 10 units as
opening stock, purchased at a cost of £500 each. Crystal
arts replenishes its stock by ordering another 10 units,
but inflation has raised costs to £600 per unit. Operating
expenses are £1000 per month and the rate of
corporation tax is 30%
1.   Define the term opening stock [2 marks]
2.   Using both FIFO and LIFO methods of stock valuation,
construct a simplified profit and loss account for Crystal
Arts to show the effects on gross profit and net profit. [ 8
marks]

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