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FIFO _ LIFO

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									       FIFO & LIFO
IB Business & Management
          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
    purchased by the business.
   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
Task               $20 per unit
Month             Stocks         Cost p/u      Stocks       Value of
                  purchased ($)                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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