Last In First Out Method (LIFO)
This method is based on the assumption that last item of materials/goods purchased are the first to be issued/sold. Thus, according to this method, inventory consists of items purchased at the earliest cost.
Illustration 4,3. Calculate the value of the inventory of January 31 from the following data using (i) periodic inventory system and (ii) perpetual inventory system.
Advantages: The method has the following advantages:
1. It takes into account the current market conditions while valuing materials issued to different jobs or calculating the cost of goods sold.
2. The method is based on cost and, therefore, no unrealised profit or loss is made on account of use of this method.
The method is most suitable for materials which are of a bulky and non-perishable type.
FIFO and LIFO Methods and Markets Fluctuations
Both FJFO and LIFO methods of pricing inventories are based on actual cost and hence both value the products manufactured at tnie costs. However, both have conflicting results in periods rising and falling prices.
In periods of rising prices. In periods of rising prices FIFO method will result in production being relatively undercharged since replenishment of stock will be at higher prices than the prices of issue of materials. On the same pattern the cost of goods sold will also be relatively deflated. Thus, profits will be inflated and there will be more liability for payment of taxes. The situation will bejust the reverse if LIFO method is followed—the production will be relatively overcharged resulting in lower pmfitabilit>, deflating profits and reducing income tax liability.
In periods of falling prices. In periods of falling prices FTh’O method will result in production being relatively overcharged, resulting in deflating the profits and reducing the income tax liability. The reverse will be the case if LIFO method is followed. Production will be charged at the most recent prices of purchase of materials or goods, resulting in inflating of profits and increasing the tax liability.
In periods of rising prices the inventory will be valued in FIFO method at a price higher than that in case of LIFO method. The reverse will be the case in case of periods of falling prices. Thus, it may be concluded that in periods of rising price LIFO method tends to give a more meaningful income statement but a less realistic balance sheet, whereas FIFO method gives a more meaningful balance sheet but a less realistic income statement The reverse will be the situation in periods of falling prices.
It may also be noted that no sweeping generalisation can be made regarding superiority of LIFO over FIFO or vice versa. Each method has its own merits and demerits depending upon the circumstances prevailing at a particular moment of time.