Managing the inventories of a company is never an easy task for companies which are entirely stock oriented. Business owners may use various ways to maintain the inventories they own (Also see Periodic Inventory System and Perpetual Inventory System). Some of the examples are first-in, first-out (FIFO), last-in, first-out (LIFO), weighted average, as well as the simple average.
Business owners need to depend on the method they use in the inventory valuation to calculate the company’s profitability, income, taxes and others. This is why hiring an accounting firm in Johor Bahru and outsource your accounting tasks is a better choice compared to doing them all by yourself if you are not familiar with accounting. Committing mistakes in accounting for inventories (Also see Counting and Auditing the Warehouse Inventory) will cause severe consequences in other parts in the financial statements and thus affects the accuracy of those statements.
In this article, the methods that we will focus on are first-in, first-out (FIFO) and last-in, first-out (LIFO).
If a company applies FIFO, it will issue or sell the stock that it receives the earliest first. This means that the company follows a chronological order in disposing of (Also see Disposal of Fixed Asset in a Company), issuing or selling its assets. The FIFO method is considered the most appropriate and logical way to measure the value of inventories. Thus, most business owners will use this method to maintain their inventories.
As there is a risk for the perishable goods to get obsolete in a period of time, handling the earliest stock first helps in minimising the risk of obsolescence. In this way, the remaining stock that the business owners have in hand will be the most recent ones, which are at the current market price (Also see What Do Market Value and Book Value Mean?).
If the company chooses to implement LIFO, it will issue or sell the stock that it receives the earliest last. This indicates that it will follow a reverse chronological order in disposing of, issuing or selling its assets. This method of handling the inventories is proved to be unreasonable and contradicts the movement of the inventories in a company. Hence, most businesses do not adopt LIFO in the inventory valuation anymore.
For a company that uses FIFO, the stock in hand are the latest ones. Thus, the cost of the unsold stock will show the present market price of those inventories. If the company uses LIFO, the stock that it has in hand are the oldest stock. In this case, it is the cost of goods sold that shows the present market price.
The IFRS (International Financial Reporting Standard) does not allow the use of LIFO in the valuation of inventories. Thus, FIFO is a method that most businesses would apply. Apart from complying with applicable standards, the concept of FIFO is easy to understand and implement too.