A survey of major U.S. companies revealed that 77% of those companies used either last in, first out (LIFO) or first in, first out (FIFO) cost flow methods, whereas 19% used average cost, and only 4% used other methods. Why are LIFO and FIFO so popular?
When prices are rising, FIFO results in lower cost of goods sold and higher net income than the LIFO method. LIFO results in the lowest income taxes because of lower net income. In the balance sheet, FIFO results in an ending inventory that is closest to the current value. LIFO is farthest from the current value.
For example, in a period of rising prices the FIFO method would provide the highest net income. Since FIFO uses the flow of goods to account for the cost of goods sold, the first goods that were in finished goods are the first expenses to be expensed in cost of goods sold. When prices are rising, the oldest goods would the lowest costs; therefore, net income would be high. Sometimes companies do not want high net income because that would incur higher taxes for that period. Therefore during times of rising prices, the LIFO method provides the lowest net income because it uses the most recent expenses in cost of good sold. Using weighed average has no real benefit because it falls in the middle of both LIFO and FIFO. Weighted average would never provide the highest or lowest net income.
The Key Concepts of AccountancyWhen prices are rising, FIFO results in lower cost of goods sold and higher net income than the LIFO method. LIFO results in the lowest income taxes because of lower net income. In the balance sheet, FIFO results in an ending inventory that is closest to the current value. LIFO is farthest from the current value.
For example, in a period of rising prices the FIFO method would provide the highest net income. Since FIFO uses the flow of goods to account for the cost of goods sold, the first goods that were in finished goods are the first expenses to be expensed in cost of goods sold. When prices are rising, the oldest goods would the lowest costs; therefore, net income would be high. Sometimes companies do not want high net income because that would incur higher taxes for that period. Therefore during times of rising prices, the LIFO method provides the lowest net income because it uses the most recent expenses in cost of good sold. Using weighed average has no real benefit because it falls in the middle of both LIFO and FIFO. Weighted average would never provide the highest or lowest net income.
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