FIFO Method
The most widely used inventory flow method for internal accounting purposes is FIFO. Under FIFO, it is assumed that materials are issued from the oldest supply in stock, and units issued are valued at the oldest cost listed on the stock ledger sheets, with materials on hand, at all times, being the most recent purchases. Under FIFO, the inventory cost is computed on the assumption that goods sold or consumed are those which have been on hand longest and that those remaining in stock represent the latest purchase or production.
FIFO tends to coincide with the actual physical movement of goods through many organizations. It is scrupulously followed for goods that are subject to deterioration and obsolescence. The ending inventory from FIFO closely approximates the actual Inventory Policies and Systems current value, as the costs assigned to the goods on hand are the most recent. While this technique tends to produce inventory assets at current costs during inflationary periods, it underestimates the value of cost of goods sold on the income statement. When the price of materials and other costs are subject to frequent change, FIFO is not likely to result in matching costs against revenues on a current basis. Thus, cost changes can create income statement distortions.
However, the FIFO method is a fairly simple one, and is compatible with the operations of many organizations. It is adaptable to both perpetual and periodic systems. The use of FIFO simplifies record-keeping activities.
LIFO Method
In the LIFO method, it is assumed that the most current cost of goods should be charged to the cost of goods sold, and hence, in LIFO, the cost of units remaining in inventory represents the oldest costs available, while the units issued are valued at the latest costs available. The underlying purpose of LIFO is to match current revenues against current costs, so the method charges current revenues with amounts approximating replacement costs.
The LIFO method may be used with both perpetual and periodic inventory systems.
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