Question

1. Explain the difference between FIFO and LIFO. Try to indicate the different consequences if a company uses them.

Answer 1

FIFO as the name suggests the material which are purchased first are issued first for production.

Advantages:
FIFO method is generally used for items with low shelf life.
valuation of ending inventory is at current prices which presents a realistic picture of the value of inventory. therefore balance sheet depicts a more realistic picture

Disadvantages:
One major diadvantage is failing to comply with matching principle because the cost of goods sold represent the oldest inventory which fails to represent current market prices . this may inflate revenues and hence higher taxes

LIFO
Last in first out. The most recent purchases are entered in production first

Adavantages.
Better matching of revenues with current levels of inventory cost
In inflationary conditions there will be tax savings as cost of goods sold will reflect higher costs hence low profits
LIFO generally depicts current position of income statement since cost of goods sold are measured at current costs.

Disadvantages.
IFRS does not allow LIFO.
sometimes LIFO method can be manipulated, as the firm may time its purchases so as to lower its profits

company chooses to use	Inflationary environment	deflationary environment
FIFO	COGS ↓	COGS ↑
	Inventory↑	Inventory ↓
LIFO	COGS ↑	COGS ↓
	Inventory ↓	Inventory↑

any method can be used by the firm, but once a choice is made it should be followed consistently so that inter and intra firm comparisons can be made and a company progress can be assessed