Inventory or stock refers to the goods and materials that a business holds for the ultimate purpose of resale. Inventories are the largest current asset of a business, and proper measurement of them is necessary to ascertain true and correct financial position of the business.

Inventory is usually valued at cost or at the market value, whichever is lower. There are three valuation methods which are most commonly used by business concerns namely First in First out (FIFO), Last in First out (LIFO) and Weighted Average Cost method.

Let us analyse Last in First out Method:

The Last- In, First- Out (LIFO) method is used to ascertain the value of inventory. The LIFO method assumes that the last item of inventory purchased is the first one sold.

Under LIFO the latest or more recent costs of products purchased (or produced) are the first costs expensed as the cost of goods sold. This means that the costs of the oldest products will be reported as inventory.

For example in a departmental store, the store keeper adds items from the front, and customers also take their selections from the front; the remaining items of inventory that are located further from the front of the shelf are rarely picked, and so remain on the shelf.

In period of Inflation, when the costs are increasing, the last items sold are the most expensive, so the cost of goods sold increases showing fewer profits.

Under LIFO the latest or more recent costs of products purchased (or produced) are the first costs expensed as the cost of goods sold. This means that the costs of the oldest products will be reported as inventory.

 

 

 

 

Through LIFO, the main advantage lies in reporting lower profits, which in turn, allows businesses to pay less tax. The LIFO system also facilitates the process of matching cost and revenue figures and allows complete recovery of material cost.

 

Even though LIFO is a simple method, inventory valuation does not talk about current prices, hence LIFO of no relevance, in assessing current situations. LIFO is also highly unrealistic as most recent purchased inventories are always used as cost of goods sold, it creates older and outdated inventories, which can never be sold. LIFO calculations are more complicated, especially when prices keep fluctuating. It is also important to note that if businesses plan to expand globally, LIFO is definitely not the right choice for valuing company’s current assets.

 

I believe having an accurate valuation of inventory is important as it affects the cost of goods sold reported on the company’s income statement. Inventory is also an important component of a company’s current assets, working capital, and current ratio.

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