First In, First Out (FIFO)
Candlefocus EditorFIFO has a number of advantages over using other inventory recording and valuation methods. The most important benefit of FIFO is that it more accurately reflects the cost of goods sold when the prices of goods fluctuate. This is because it assigns the oldest and lowest cost inventory to cost of goods sold. This, in turn, increases the net income that would have been earned in an inflationary market.
Another advantage of FIFO is that it more accurately reflects the cost of newly-acquired inventory and can be used as a reference for future purchases to ensure a better and more realistic cost of items. This is because in FIFO, the valuation and accounting records capture costs related to older inventory.
In addition, FIFO has the advantage of no need to adjust cost basis when new inventory is added or when the sale of inventory is made. This makes it easier to track the cost of goods sold from any given period.
However, there are some downsides to using the FIFO method. One of the major disadvantages is that it does not clearly represent the physical flow of inventory, as inventory items acquired last can be sold first and vice versa. Thus, it does not accurately reflect the actual costs associated with the most recently acquired inventory items.
In contrast to FIFO, LIFO (Last In, First Out) is an accounting methodology where costs for goods sold are based on the assumption that the most recently acquired inventory are the first to be disposed of.
Although FIFO is the more commonly used inventory valuation method, the choice between FIFO and LIFO should be based on the situation and needs of the business. It is important to note, no matter which method used, that taxes are then examined on the income.