What Is Last In First Out (LIFO) Method ?
Inventory valuation method in which most recently purchased, acquired or produced materials are issued or sold first is called last in first out (LIFO) method. In this method of recording inventory, last batch of materials are issued first and previous batch remains on the stock. In LIFO, value of closing stock is determined on the basis of previous price which is generally lower than the latest price.
Benefits Of Advantages Of LIFO Method
The main advantages of LIFO method of recording inventory can be highlighted as follows:
1. Tax Advantage
This method shows higher cost of good sold because of the rising price of materials. Higher cost of goods sold lowers taxable liability of the company. So, firm can enjoy the benefit of tax reduction.
2. Better Measurement Of Cost
In LIFO, recent costs and current revenue are matched which prevents understating the cost of good sold and overstating of profit.
3. Suitability
This method is appropriate when the price of the products is rising because it reduces taxable income and improves cash flow of the business.
4. Realistic Result
LIFO method shows more accurate and realistic result (profit or loss) than first in first out (FIFO) method of inventory.
Drawbacks Or Disadvantages Of LIFO Method
Some of the major disadvantages Of LIFO are as follows:
1. Complex Method
Last in first out (LIFO) method is more complicated, complex and consumes more clerical work than FIFO. It is difficult to compare the cost of similar jobs because of the price variation.
2. Not Suitable
It is not suitable for perishable goods having very short life. Because they cannot be stored or preserved for long period.
3. Understatement Of Inventory
In this method, value of inventory is computed on the basis of oldest cost. So, it understatements the value of materials on the stock.
4. Manipulation Of Income
There exists a chance of income manipulation by changing purchase pattern.
Also Read:
Advantages And Disadvantages Of FIFO
Difference Between LIFO And FIFO
5. Not Popular
LIFO is least preferred method of inventory. It is not popular and widely used like other methods because of its complications at the time of price fluctuation.
Pros And Cons Of LIFO In Short
Pros:
- It provides tax benefit
- It shows more realistic result
- It is appropriate when the prices of the products are rising
- It discourages understating of cost of good sold
Cons:
- It is more complicated than other methods
- It is not suitable for perishable goods
- Possibility of manipulation of income
- It is not preferred by tax authorities
- It understates the value of stock