First In First Out vs. Last In First Out: Strengths and Weaknesses
DEPARTMENT OF ACCOUNTANCY
UNIVERSITY OF ILLINOIS
MEMORANDUM
TO: Raluca Chiorean
FROM: Section AE2
DATE: June 30, 2012
SUBJECT: Samuel’s Electronics Analysis
INTRODUCTION
In this memorandum, I’ll discuss strengths and weaknesses of using FIFO versus LIFO as the cost flow assumption in the accountant’s process of inventory valuation for financial statement reporting to a company’s external stakeholders.
FIFO AND LIFO ANALYSIS
As shown in the exhibit, because the price of LG TV was decreasing, Samuel’s Electronics would record less cost of good sold and consequently have greater ending inventory value utilizing LIFO inventory system. The company would generate higher net income and increase the earnings. Also, LIFO could reflect the most recent costs with current revenues, whereas FIFO could not. Therefore, when the company decided to apply LIFO method to record sales and expenses, the financial report would look better than the company’s actual performance. However, LIFO did not approximate the actual physical flow of inventory and understated the ending balance of inventory relative to current costs. Therefore, there was a larger chance that manager could use LIFO to manipulate the net income by reducing year-end production or purchases. The external stakeholders would not receive the reliable and accurate information from financial reports.
On the other hand, using FIFO to record inventory sales and expenses would properly reveal the physical flow of inventory. The external stakeholders could easily track the company’s inventory operation. However, it would not reflect the current price of inventory. In Samuel’s case, since the price the purchasing LG TV was decreasing, the overall cost of good sold was overstated as result.
CONCLUSION
There is no better or worse option between LIFO and FIFO. Both advantages and disadvantages exist in LIFO and FIFO inventory system. Which one to choose depends on company’s business strategy and accounting rules.
UNIVERSITY OF ILLINOIS
MEMORANDUM
TO: Raluca Chiorean
FROM: Section AE2
DATE: June 30, 2012
SUBJECT: Samuel’s Electronics Analysis
INTRODUCTION
In this memorandum, I’ll discuss strengths and weaknesses of using FIFO versus LIFO as the cost flow assumption in the accountant’s process of inventory valuation for financial statement reporting to a company’s external stakeholders.
FIFO AND LIFO ANALYSIS
As shown in the exhibit, because the price of LG TV was decreasing, Samuel’s Electronics would record less cost of good sold and consequently have greater ending inventory value utilizing LIFO inventory system. The company would generate higher net income and increase the earnings. Also, LIFO could reflect the most recent costs with current revenues, whereas FIFO could not. Therefore, when the company decided to apply LIFO method to record sales and expenses, the financial report would look better than the company’s actual performance. However, LIFO did not approximate the actual physical flow of inventory and understated the ending balance of inventory relative to current costs. Therefore, there was a larger chance that manager could use LIFO to manipulate the net income by reducing year-end production or purchases. The external stakeholders would not receive the reliable and accurate information from financial reports.
On the other hand, using FIFO to record inventory sales and expenses would properly reveal the physical flow of inventory. The external stakeholders could easily track the company’s inventory operation. However, it would not reflect the current price of inventory. In Samuel’s case, since the price the purchasing LG TV was decreasing, the overall cost of good sold was overstated as result.
CONCLUSION
There is no better or worse option between LIFO and FIFO. Both advantages and disadvantages exist in LIFO and FIFO inventory system. Which one to choose depends on company’s business strategy and accounting rules.