Meaning of LIFO
An acronym for Last in, First out, the LIFO method presumes that the assets acquired or produced last are sold, used, or disposed of first. As explained by Investopedia, LIFO presumes that a business entity sells, disposes, or uses its most recent stock first. If, in case, an asset is sold for more than its purchase value, the difference is considered as a capital gain. On the contrary, if the same is sold for less than the purchase price, the difference is considered as a capital loss. Use of LIFO method for evaluation and management of inventory can be advantageous for taxation, but might also increase tax liability at the same time.
Advantages and Disadvantages of LIFO Method
- The cost of issued materials is either close to or will reflect the current market price. The cost of goods produced will, therefore, be related to the trend of the materials’ market price.
- The use of LIFO method during the period of increasing prices does not imply undue high profit in the income statement since it was under the average or the first-in-first-out method. Indeed, the profit presented here is relatively lower for the production cost takes into consideration the rising trend of prices for material.
- In periods of falling prices, profit tends to rise because of lower material cost. The finished products, however, appear to be more competitive in addition to being at market price.
- Over a certain time period, the use of LIFO method is helpful in ironing out the profit fluctuations.
- During the inflation period, LIFO will tend to show the accurate profit thereby avoiding undue taxes to some extent.
- The LIFO method of evaluating material is not acceptable to the IT authorities.
- Costs of different analogous batches of production being carried on at the same time might differ a great deal.
- Calculation through LIFO method becomes complicated and unwieldy if frequent purchases are made at highly fluctuating rates.
- During the period of falling prices, need for writing off stock value might arise, significantly to stick to the principle of stock valuation, i.e., the market price or the cost, whichever is lesser.
LIFO method was abrogated under IFRS and national GAAPs of some countries.