FIFO and LIFO accounting

This article does not cite any references or sources. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. (November 2007)

FIFO and LIFO accounting Methods are means of managing inventory and financial matters involving the money a company ties up within inventory of produced goods, raw materials, parts, components, or feed stocks. FIFO stands for first-in, first-out, meaning that the oldest inventory items are recorded as sold first. LIFO stands for last-in, first-out, meaning that the most recently purchased items are recorded as sold first. Since the 1970s, U.S. companies have tended to use LIFO, which reduces their income taxes in times of inflation.^[1]

LIFO liquidation

Notwithstanding its deferred tax advantage, a LIFO inventory system can lead to LIFO liquidation, a situation where in the absence of new replacement inventory or a search for increased profits, older inventory is increasingly liquidated (or sold). If prices have been rising, for example through inflation, this older inventory will have a lower cost, and its liquidation leads to the recognition of higher net income and the payment of higher taxes, thus reversing the deferred tax advantage that initially encouraged the adoption of a LIFO system. Some companies who use LIFO have decades-old inventory recorded on their books at a very low cost. For these companies a LIFO liquidation results in an inflated net income (and higher tax payments). Companies can use liquidations to manage their earnings.

See also

• Average costing

References