FIFO and LIFO Methods for Inventory Expensing
Inventory refers to the short-term assets on a company’s balance sheet; example – a retail clothier’s stock of shirts, pants, etc.
First-in, first-out accounting method, where the costs of the oldest items in inventory are used to compute the cost of goods sold (COGS) expense on a company’s income statement.
FIFO ending inventory for the balance sheet is calculated based on values of the most recent inventory goods purchased.
Last-in, first-out accounting method, where the costs of the newest inventory items are used to compute the COGS expense on the income statement.
LIFO ending inventory for the balance sheet is calculated based on values of the first inventory goods purchased.
Weighted average cost method applied to a company’s purchases in determining COGS and the value of beginning and ending inventory.
COGS Expense Calculation
Beginning Inventory (BI) + Purchases = Goods Available for Sale (GAS)
GAS – Ending Inventory (EI) = COGS
COGS is used in calculating a company’s gross profit and gross profit margin (the decimal is typically converted to a percentage)
Gross Profit = Net Revenue - COGS
Gross Margin % = ((Net Revenue – COGS)/Net Revenue)*100
In some instances, the choice of LIFO or FIFO makes intuitive sense for a specific company. A farmer’s market shop would conceptually be a FIFO business, as the oldest produce should be sold first, given that it will spoil the soonest compared to younger produce.
In reality a company’s management is usually allowed some degree of flexibility in determining its inventory accounting method. If an analyst is comparing firms in a shared industry structure or market capitalization size, then differences in inventory accounting methods need to be reconciled through the financial statement adjustment process, so the analyst can be sure that the financial ratios for the firms are truly comparable.
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- CFA Level 2: Financial Reporting Part 1 - Introduction
- Financial Reporting: Important Definitions
- FIFO and LIFO Methods for Inventory Expensing
- Inventory Accounting and Financial Statements
- Inflation/Deflation and Inventory Accounting Analysis
- LIFO – Tax and Cash Flow Note
- LIFO Reserve and Converting LIFO Net Income to FIFO Net Income
- LIFO Liquidation
- Inventory at Net Realizable Value
- Impacts of LIFO and FIFO Inventory Methods on Selected Financial Ratios
- Accounting of Long-lived Assets - Expensing vs. Capitalizing
- Depreciation Methods for Property, Plant, and Equipment (PPE)
- Impact of Depreciation Method
- Depreciation - Important Points
- Impairment of Long-lived Assets
- Impact of Asset Impairment
- Revaluation of Property, Plant, & Equipment (PPE)
- Leasing versus Purchasing Assets
- Traditional Lessee Accounting in US GAAP
- Effects of Leases on Selected Financial Reporting Items for Lessees
- Lessor Accounting for Leases
- Lessors and Sales-Type Capital Leases
- Lessors and Direct Financing Capital Leases
- Effect of Leases on Financial Statements for Lessors
- Future of Lease Accounting
- CFA Level 2: Financial Reporting 1 - Recommendations