Akita T
Caldari
Caldari Navy Volunteer Task Force
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Posted - 2009.10.27 00:07:00 -
[1]
In an inflation scenario (material prices go up), the FIFO inventory method undervalues your liabilities ("used up" stocks) and overvalues your remaining stock while the LIFO method (depending on how you look at it) either overvalues or perfectly estimates liabilities while possibly undervaluing remaining stock.
In this case, FIFO lets you "claim" lower costs and higher profits early, drastically reducing future reportable profits if the inflation ceases or you try to liquidate the stocks ; conversely, LIFO more or less accurately reports current costs but can only claim lower profits, however in case the inflation ceases or you liquidate your stock your future reportable profits will actually go up.
In a deflation scenario (material prices go down), the FIFO inventory method overvalues your liabilities ("used up" stocks) and undervalues your remaining stock while the LIFO method (depending on how you look at it) either undervalues or perfectly estimates liabilities while possibly overvaluing remaining stock.
In this case, LIFO more or less accurately reports current costs and can "claim" lower costs and higher profits early, but ignores older, more expensive stocks and therefore it drastically reduces reportable profits if the deflation ceases or you are trying to liquidate the stocks ; conversely, FIFO more or less accurately reports historic costs but claims lower profits, however in case the deflation ceases or you try to liquidate the stocks your future reportable profits will actually go up.
Obviously, your total profits in either case are exactly the same, it's only a matter of when you prefer them to be reported (and on whether you are planning to liquidate stocks or not).
If there's no material price movement, both FIFO and LIFO methods perfectly evaluate your stock's value, as there's absolutely no difference in the calculations.
Obviously, the moving and/or weighted average methods fall somewhere in-between FIFO and LIFO, so, for all intents and purposes, it's a much more accurate (and "honest") depiction of inventory/stock/liabilities values.
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