TaxesandScotch
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LIFO accounting
In LIFO accounting, a historical method of recording the value of inventory, a firm records the last units purchased as the first units sold. LIFO is an acronym for "last in, first out." Sometimes the term FILO ("first in, last out") is used synonymously. LIFO accounting is in contrast to the method FIFO accounting covered below.
Since prices generally rise over time, this method records the sale of the most expensive inventory first and thereby can reduce taxes. However, this method rarely reflects the physical flow of indistinguishable items (perhaps a heap of coal with shipments being added to and taken from the top might be an isolated case) and is not permitted under UK GAAP and IAS.
However, LIFO valuation is permitted under US GAAP in the belief that an ongoing business does not realize an economic profit solely from inflation. Canadian GAAP permits its use for reporting purposes, while the Canada Revenue Agency does not allow LIFO to be used for tax filing. When prices are increasing, they must replace inventory currently being sold with higher priced goods. LIFO better matches current cost against current revenue. It also defers paying taxes on phantom income arising solely from inflation. LIFO is attractive to business in that it delays a major detrimental effect of inflation, namely higher taxes.
Because LIFO often delays the recognition of profits and defers tax payments, businesses may request permission from the IRS to use the LIFO method by filing IRS Form 970, Application To Use LIFO Inventory Method.
FIFO accounting
FIFO accounting is a common method for recording the value of inventory. It is appropriate where there are many different batches of similar products. The method presumes that the next item to be shipped will be the oldest of that type in the warehouse. In practice, this usually reflects the underlying commercial substance of the transaction, since many companies rotate their inventory. This is in contrast to LIFO.
In an economy of rising prices (during inflation), it is common for beginning companies to use FIFO for reporting the value of merchandise to bolster their balance sheet. As the older and cheaper goods are sold, the newer and more expensive goods remain as assets on the company's books. Having the higher valued assets and the lower purchase costs of the sold goods part of the company's books, increases the chances of getting a loan from potential creditors for the company. However, as the company grows it may switch to LIFO to reduce the amount of taxes it pays to the government.
 Posted 538 days ago
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