[RAVISHING GIRL1]

Hello!
I want to ask question about the L.I.F.O (Last in Last Out).
Question is:
Where do companies use the L.I.F.O. Method.
Thanks for you advise.:)

[morgaine300]

Not sure what you mean by "where." Like applied to what type of thing? Usually the first place you learn to apply it is merchandise inventory. When you sell merchandise, you have to know what dollar amount to use to account for the company's own cost of it. If their cost has been changing and they have inventory that cost them different amounts, they have to decide which cost to use with any particular sale. And there's where the LIFO would come in. They would with the costs of the last thing that came in.

Theoretically it could be applied to anything, but the things that are popping into my head right now are all FIFO.

[RAVISHING GIRL1]

Hello!
I want to ask question about the L.I.F.O (Last in Last Out).
Question is:
Where do companies use the L.I.F.O. Method.
Thanks for you advise.:)

Hi
I meant is that What are the benefits of L.I.F.O. method because majority companies use F.I.F.O. method What is the use of L.I.F.O. in companies?
Thanks for your advice

[morgaine300]

Asking that is opening up a can of worms. :-) If prices don't change, it doesn't really make any difference.

As a general rule we have inflation, so let's go with that assumption. To make it over-simple, let's say you only purchased two items to sell, one at $100 and one at $120, in that order. Let's also say the current purchase cost is still $120. You might want to write all this down if you truly want to follow it.

When you sell one (at a higher price, hopefully), you have to recognize your cost of buying it. If you use FIFO, you'll expense off the $100, the first one. That will leave the
$120 one in your ending inventory. That expense will be lower than if you'd expensed the $120 one. When expenses are lower, net income will be higher. So using that method produces higher operating income. From an income statement point of view, that looks better on the books. From a balance sheet point of view, it looks better also cause you have a higher one left in ending inventory. Inventory is an asset, a resource for the company. So your advantage with FIFO is income appearing higher, and also you are matching up the order of purchases with sales, and matching it with the actual physical flow of the inventory. The disadvantage is that if your income is higher, that also means paying higher taxes. And since ending inventory is higher, that can also mean higher property taxes. (That may depend on local rules, which are all different.)

Now, if you're doing LIFO, when you sell that one item, you're going to recognize the $120 as being your cost and expense that amount. (last in) This leaves $100 for ending inventory. So you have a bigger expense, resulting in a smaller net income. The advantage here is that it's better for tax purposes, because the smaller net income has less tax. But it does look worse on the income statement and also looks worse on the balance sheet.

This may be tough to follow. But in summary: FIFO creates higher income on the income statement and a higher current asset on the balance sheet. It also creates higher tax. LIFO creates lower income on the income statement and a lower current asset on the balance sheet. But it's lower tax.

But then the real monkey wrench is replacement value. I'm a proponent of FIFO and disagree with what I'm about to tell you, but I see the point. (Obviously lots of people disagree with me or both methods wouldn't exist.) If I use FIFO, and therefore use the $100 as my cost and therefore my expense, my income statement would show that I "profited" $20 more than if I did the LIFO method. But if replacement cost is currently $120, then the $20 profit is considered to be tied up in replacement inventory and therefore is not really profit. It's what some call "phantom profit." LIFO people think this distorts the income statement. FIFO people think that LIFO distorts the balance sheet, because it's reflect an older value instead of current. No matter how you look at it, the effect on income statement and effect on balance sheet are in conflict. And the LIFO people are putting more emphasis on the fact that the extra $20 showing on the income statement isn't really profit since you needed to use it for current inventory prices. i.e. they're more concerned with current value of the inventory.

I'd call "phantom profit" something that was truly done for the sole purpose of making the books look better, or trying to hide some expense. i.e. something done for a bad reason. FIFO is a legitimate method, and as long as you disclose the method you're using and aren't doing it just to make the books look better, there's nothing wrong with it.

A third method, weighted average, also exists, which ends up in the middle of LIFO and FIFO, and maybe it would be a good compromise and make everyone happy. :-)

This may have all sounded a bit complicated, but unfortunately it's a complicated subject if you actually want to understand the why's behind it. But you asked. :-)

[RAVISHING GIRL1]

Thanks for your answer. Now I have understand it.