Many of us may have heard about the
FIFO and LIFO in cost accounting but may not have a clear idea about it. While to some of you it may be a new topic in
cost accounting. So today I have decided to make you understand about the FIFO
and LIFO in this article.
FIFO
FIFO stands for First In First Out. FIFO is a method of pricing a
material issues. In this method we assume that the materials are to be issued
to the production in the order in which it has been purchased i.e. materials
purchased first is to be issued first and later the second lot and third lot
and so on.
Advantages of FIFO
The advantages of FIFO method of
pricing material issue are,
§ FIFO is simple and easy to use.
§ It is a fairly a practical approach to use the inventory.
§ It is widely used and accepted method of valuation of which
increases its consistency and comparability.
§ The manipulation in financial statements is difficult when using
FIFO.
§ It helps to show the increased
profits during the increased prices as the cost of production is
decreased by the inventory purchased at lower prices.
Disadvantages of FIFO
The advantages of FIFO method of pricing material issue are,
§ FIFO increases the profits during the high inflation and due to
this the business firms tax liabilities increases which means the cash out flow
increases.
§ This method cannot be applied when there is hyper Inflation.
§ FIFO applied for goods or materials that have fluctuation during
prices pattern has higher chances of clerical errors.
§ FIFO is also based on the inflation rate which means that the
demand and supply, transfer pricing and other such factors influence. Thus the
pricing of material is influenced by various factors and does remain dependent
on other factors.
§ Cost Decisions during the inflation periods doesn’t remain
reliable.
LIFO
LIFO stands for Last In First Out.
LIFO is also a method of pricing material issues. In LIFO we assume that the
material are to be issued to the production in reverse order i.e. the material
purchased recently or lastly is to be issued first to the production and later
second lot and then the first lot and so on.
Advantages of LIFO
The advantages of LIFO method of pricing material issue are,
§ LIFO gives better measurement of current earnings as it takes most
recent cost and current revenue into account.
§ During Inflation the LIFO helps to lower the profits by having
increased cost of production leading to tax benefits.
§ LIFO helps to minimize the write downs to the market.
§ Cost Decisions remains to make sense in inflation and in absence of
inflation.
Disadvantages of LIFO
The disadvantages of LIFO method of pricing material issue are,
§ During inflation period the business shows the low earnings.
§ LIFO understates the inventory figure and makes working capital
look worse than it really is.
§ LIFO liquidation often inflates the income for a period which will
result in higher tax payments for that period.
§ The financial statements can be easily manipulated by changing the
purchasing pattern at the end of the year.
Comments
Post a Comment