Using the following imaginary company data the differing effects using LIFO vis-à-vis FIFO will be shown and explained. Assume a physical count determined 20 units in ending inventory.
The first-in-first-out (FIFO) method assumes that the first units purchased are the first unit sold and to be expensed to cost of goods sold (COGS); therefore, the units remaining in ending inventory (EI) are comprised of the latest units to be purchased. The last-in-first-out (LIFO) method assumes the latest units purchased are the first units to be sold and to be expensed to COGS; therefore, the units remaining in EI are comprised of oldest units, that is, beginning inventory and then the oldest purchases. The figures above show that the FIFO cost valuation results in a COGS that is less than that computed when using the LIFO cost valuation. Generally, as time progresses the cost of units will increase, and since FIFO’s EI prices are more recent than those when using LIFO the remaining EI units will have a greater replacement cost; the resulting higher FIFO EI creates a lower COGS that LIFO. Assuming all other income statement elements remain constant a lower FIFO COGS leads to a lower income compared to higher LIFO COGS.
Inventory is the current asset affected by the two methods. As mentioned the FIFO EI is comprised of the most recent and generally more expensive purchases compared to the LIFO EI comprised of the older, less expensive purchases, and BI; therefore, an accounting system using the FIFO method will result in an EI that is higher than an accounting system that uses the LIFO costing system.
Referance
Hermanson, R.H. and Edwards, J.D. and Rayburn, L.G. (1989). Financial Accounting. Homewood, IL: Richard D. Irwin, Inc.
