In the management of inventory by a firm there exist different techniques of valuing inventory at hand and that which has been acquired. The most famous and employed techniques are LIFO and FIFO.LIFO is an acronym referring to Last in First Out while FIFO refers to First in First Out.
The gross difference between the two techniques is how the inventory is valued before it leaves the warehouse to the processing unit,(walther,2012)
In last in last out (LIFO) model the inventory per unit leaving the warehouse is valued at the price in which the last acquired inventory is valued per unit. In Fist in First out (FIFO) the inventory per unit is valued the price in which the earliest acquired inventory was valued per unit.
These types of valuation have a significant and noticeable impact on the income statement of the firm and likewise on the profitability of the firm. From the definition LIFO method of valuing the inventory reflects on the prevailing market prices of the acquired inventory and thus to an extent realistic however if earlier stocks were acquired at lower price while the current stock are acquired at a higher price the difference will be a dishonest inflation on the price of earlier acquired stocks which are being used at present.
On the same note of LIFO, if stocks were acquired earlier higher price and in the present moment of use they are valued below their acquisition prices, the difference will be a loss to the company and this will be against the prime motive of every business which is to maximize the profit from its activities.
Taking a similar reflection on First in First Out (FIFO), this method of inventory valuation involving valuing every unit of the stock leaving the warehouse at a per unit price in which past the earliest unit in the stock was acquired at. This method unlike LIFO does not reflect on the market price of the stock as it utilizes past prices.
Analyzing this methods its true to say that if past units of the inventory were acquired ata lower price than the present prevailing prices, the firm will be overvaluing the cost of the stock leaving the warehouse and this will be an abnormally earned profit to the company. Likewise if the inventory leaving the warehouse now was acquired at a higher price than the present price then the company will incur a loss which is against the business motive of optimizing its profit on the higher end.
It is crystal clear now that the two methods of valuing stock work directly opposite and none is more advantageous than the other generally. The choice of the inventory valuation techniquewhich the controller of Sagehen Enterprise would opt to adopt can be weighed on the historical performances of the company performances by comparing results from both techniques and how they impact on the enterprises profitability. The choice to switch off should not be done on trial and error basis but on calculated facts, (Walther,2012).
Reference:
Walther (2012).Principles of Accounts: Volume 1.San Diego,CA: Bridgepoint Education,Inc.
