Question

Why must we be able to distinguish between LIFO and FIFO? What importance does this hold in the accounting field?

Answer 1

Meaning:

Under FIFO the basic assumption is that the oldest inventory is used first. Due to this, the closing inventory is valued on your balance sheet at a cost closest to the current cost since prices tend increase over time. The cost of goods sold is based on a lower cost since older and therefore cheaper items are assumed to be the items sold.

Under LIFO the assumption is that the last items purchased are the items sold, meaning the more expensive items were used. The cost of goods sold is therefore relatively higher and the value of goods remaining on the balance sheet is lower since those are older items purchased at a lower price. Under LIFO your profits are lower compared to FIFO accounting.

Assumption: Assuming that prices of inventory have increased over the time in both cases.

Why knowledge of LIFO and FIFO is it important:

If you sell products and the cost of your supplies or products tends to increase over time (and what doesn't cost more over time?) using LIFO will typically result in lower taxable income compared to the FIFO.

But keep in mind that if you need to maintain a relatively strong balance sheet to qualify for loans, to satisfy investors, or to impress analysts FIFO may be the way to go.

Hence, depending upon the nature of your business and your short-term and long-term goals.Then pick one of the method that's a lot more important in generating revenue and making profits. Therefore it is necessary to able to distinguish between LIFO and FIFO method for inventory.