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LIFO or FIFO

Inventory management is a crucial function for any product-oriented business. "First in,
First Out," or FIFO, and "Last in, First Out," or LIFO, are two common methods of
inventory valuation among businesses. The system you choose can have profound
effects on your taxes, income, logistics and profitability. Here are the major differences
between the two.

FIFO

Companies operating on the principle of "First in, First Out" value inventory on the
assumption that the first goods purchased for resale became the first goods sold. In some
cases, this may not be true, as some companies stock both new and old items.

Due to the fluctuations of the economy and the risk that the cost of producing goods will
rise over time, businesses using FIFO are considered to be more profitable — at least,
on paper. For example, a grocery store purchases milk at regular intervals to stock its
shelves. As customers purchase milk, the stockers push the oldest product to the front of
the fridge and replace newer milk behind those cartons. The cartons of milk with the
nearest expiration dates are thus the ones first sold, whereas the later expiration dates
are sold after the older product. This ensures that older products are sold before they
perish or become obsolete, and then become profit lost.

Companies that sell perishable products or units subject to obsolescence, such as food
products or designer fashions, commonly follow the FIFO method of inventory valuation.

Anil Melwania, CPA with New York accounting firm 212 Tax & Accounting Services,
said that because prices rise in the long term, the choice of accounting method can
significantly affect valuations.

"FIFO gives us a better indication of the value of ending inventory on the balance sheet,
but it also increases net income, because inventory that might be several years old is
used to value the cost of goods sold," Melwania told Business News Daily. "Increasing
net income sounds good, but remember that it also has the potential to increase the
amount of taxes that a company must pay."

For businesses needing to impress investors, this becomes an ideal method of valuation,
until the higher tax liability is considered. Because FIFO results in a lower recorded cost
per unit, it also records a higher level of pre-tax earnings. And, with higher profits,
companies can likewise experience higher taxes.

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