COMPARATIVE STUDY ON FIFO, LIFO AND AVERAGE COST.

FIFO: First in, first out, usually regarding the sale of stock. Unless otherwise specified, the specific shares sold in an account will be the first shares that were bought. Fiscal year A 12 month accounting period. Under the FIFO method, the cost of the earliest goods purchased are the first to be recognized as cost of goods sold. Assuming an inflationary economy, this method of inventory tracking will provide the highest gross profit for the period. At the same time this method also states that the remaining inventory was purchased at the highest price level. For Instance; If a whole seller follows FIFO method, he will start to sell his proudct from those units which are bought first and which are supposed to be first inventory in his business. Advantages of FIFO Method In period of rising price, FIFO produces a higher net income. The value of the closing stock on the balance sheet comprises more current costs than if WAVCO or LIFO is used. The cost flow approximates the actual physical stock movement. Therefore, the value of the closing stock reflects the current replacement cost. Unrealized profits or losses will not occure, i.e.increases in stock values due to inflation. This statement of standard accounting practice prescribe that stock should be valued at the lower of cost or net realizable value. Disadvantages of FIFO Method LIFO: It does not match recent costs with current revenues as well as LIFO does During periods of inflation, the reported profits include holding gains and normal operating profits. It yields a higher taxable income than the LIFO and WAVCO methods. It does not assist in fixing the selling price because it may result in an unrealistic pricing structure. Doesnt minimize taxes, so there will be less cash available for use in the business.

LIFO method assumes that the latest goods purchased are the first to be sold. Under LIFO, the cost of goods sold is based upon the cost of material bought towards the end of the period, resulting in costs that closely approximate current costs. The inventory, however, is valued on the basis of the cost of materials bought earlier in the year. During periods of inflation, the use of LIFO will result in the highest estimate of cost of goods sold among the three approaches, and the lowest net income. For Instance; If a whole seller follows LIFO method, he will start to sell his proudct from those units which are bought last and which are supposed to be last inventory in his business. Advantages of LIFO Method Reflects current costs & Minimizes taxes in inflation, so more cash available for use in the business. If price are falling FIFO will report the lowest net income and LIFO the highest. It matches current revenue with more recent costs, and gives more accurate normal operating profits. During periods of inflation, it yields a lower reported income than FIFO and WAVCO (weight average cost) methods. It provides a more realistic basis for price determination. Disadvantages of LIFO Method

The inventory represents the earliest acquisition costs. During periods of inflation, the value of the closing stock may be well below the current cost of replacement. Thus, it is an unrealistic measure of current assets on the balance sheet. It is complicated to be used when a company has many different products. The reported profits may fluctuate widely over time. When the stock is exhausted, the earliest costs (usually the lowest costs) are matched with the current revenues. It may result in a periodic peak in profits. Easy to manipulate and it produces bad ending inventory valuation. also physical flow is unrealistic

Average Cost:

The average cost method assumes that the goods available for sale have the same (average) cost per unit. Under this method, the cost of goods available for sale is allocated on the basis of the weighted-average unit cost. A sample computation average unit are as follows.
Cost of Goods Available for Sale Unit Cost $12,000 = Total units available For Sale Weight- Average

/ $12.00

1,000

Advantages of Weight Average Cost Method It assigns an equal unit cost to each unit of stock It reduces the profit and loss fluctuations. The value of the closing stock tends to approach the replacement cost. Disadvantages of Weight Average Cost Method

It does not match recent costs with current revenues as well as LIFO does. The closing stock does not reflect the current replacement cost as under FIFO. It is more complicated to apply than the FIFO and LIFO methods.

#Items

Unit Cost

Total Cost

Beginning inventory Purchase #1 Purchase #2 Purchase #3 Goods Available for sale

200 400 300 350 1,250

$12.00 13.00 13.70 14.20

$2,400 5,200 4,110 4,970 $16,680

Unit sold $17400

870

At $20

Units remaining

380 Under First-in, first-out (FIFO):

Remaining units:

350 x 14.20 30 x 13.70 380........... .. 16,680 5,381 11,299

4,970 411 5,38l

ending inventory $17,400 11,299 $6,101

Goods Available for Sale -Ending inventory =Cost of goods sold

Net sales -Cost of Goods Sold Gross Margin

Under Last -in first out (LIFO) : 200 x 12.00 Remaining 180 x 13.00 units: 380........... .. 2,400 2,340 4,740

ending inventory

Goods Available for Sale -Ending inventory =Cost of goods sold

16,680 4,740 11,940

Net sales -Cost of Goods Sold Gross Margin

$17,400 11,940 $5,460

Under Weighted average: 16,680/1,250 = $13.344 x 380 = $5,071 ending inventory Goods Available for Sale -Ending inventory =Cost of goods sold 16,680 5,071 11,609 Net sales -Cost of Goods Sold Gross Margin $17,400 11,609 $5,791

SUMMARY OF THREE METHODS FIFO Gross Margin Ending Inventory $6,101 $5,381 W.Avg. $5,791 $5,071 LIFO $5,460 $4,740

As you can see, the analysis is difficult and the decision as to whether to use FIFO, LIFO, or some average needs to be carefully analyzed. All are legal; however, you need to be wary about which method you use based on the advantages and disadvantages discussed above.