From my view, I would use LIFO because it is a more fair and ethical profit distribution. Some unscrupulous owners might employ the FIFO approach to store the inventory for a longer period while at low prices and wait for the best prices to sell them out. This is especially happening during the shortage of household goods because they can use these price differences to reap maximum profit. For example, in year 1 you buy 1 gallon of crude oil at $65, you store the petrol until year 3 or year 4, then the crude oil prices shoot up to $115, they can earn more profit than ever and reap maximum profit. This looks good on the balance sheet despite tax is incurred higher. However, the additional profit earned is enough to cover the additional tax incurred. That's why the flaws of FIFO is exploited by merchants to gain more profit. In short, I will choose FIFO from the unethical side to yield maximum earnings while using LIFO to provide good quality of products and services as the quality of new inventory is much assured than old inventory. This leaves good satisfaction to the customers.
In this video I explain FIFO, LIFO and average cost methods to value the stocks stored by a company, to estimate the cost of goods sold and to determine the commercial result (profit or loss) of the firm: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-mOM1Lqqydos.html.
Can you change from LIFO to FIFO or vice versa from one accounting period to another. Let's say at the end of the year, I will have turned over a lot of inventory from holiday business and will have higher profits under FIFO that I'll have to pay more taxes on; COGS remains consistent through the year. Can I switch in 4th quarter (or for my December accounting period) from FIFO to LIFO in order to minimize taxes paid on profit (from that very high December holiday sales inventory turn over)?
damn! accounting is really interesting, I'm a software engineer working on an an accounting software and was doing some research and stumbled upon this
In the world of banking system, where money is created out of thin air (thanks to central banks and also commercial banks with fractional reserves) which creates inflation, it would be normal to use LIFO in order to capture REAL profit (not nominal), therefore using the latest price. But I guess governments are not interested whether companies are in REALity profitable, they just want our money. The higher nominal profit, the higher collected taxes.
its a very common sense matter.. if someone sale something from a bulk of stock, they should sale the old ones at old rates , accordingly, so FIFO is super natural ways
Sir. I am from India.I think LIFO is most preferable in Real-estate , Gold & Diamond Business. In other way FIFO is Maintaine Pharmacy, Beverage & Other Business ..
I think your slide on FIFO vs LIFO differences doesn't seems to be right ( 4 min:19 sec). FIFO at lower prices will give lower profit and lower taxes. Is it a typo or Am I missing something?
Hey Zach. Just a comment (well, actually a question) from my interpretation based on your last example around 5:42 - Using LIFO, your GP is 50% and under FIFO it's 75%. However, (and this is an assumption on my part about US GAAP) after a year or so you have to consider an inventory write-off of the obsolete inventory. This can either be added to Cost of Sales, reducing your GP margin, or added to an overhead cost reducing the Nett Profit. On both cases, it reduces the Nett profit from before the write off. Now, if you've been using FIFO, your cost GP% on year 1 would be larger, yes, but in year 2 it would be much smaller. So essentially LIFO is an overall larger profit reduction on a shorter period, but in the long term the average profit (and as a result, tax liability) is the same regardless of LIFO and FIFO.
Absolutely correct! Good analysis. On a theoretical level, it should all average out in the end... except it doesn't in practice. For instance, large global oil companies never write-off inventory as obsolete (oil doesn't go bad), which locks in their cost savings forever.
Thanks, Zach. Being from an oil importing country we don't look at it from that point of view. However would probably be true for a couple of our larger mines (gold, diamonds, platinum etc.), the difference is we're on IFRS, so LIFO is not allowed. I'm enjoying this series, thanks again.
Thank you for making this topic clear and brief. Since I have a hard time understanding long videos. You have explained it in a very easy way for anyone who has no clue about FIFO and LIFO.
