LIFO

LIFO short form of last in, first-out, it a method of costing inventories assumes that the costs of the last items purchased should be assigned to the first items sold and that the cost of ending inventory should reflect the cost of the goods purchased earliest.  The effect of LIFO is to value inventory at the earliest prices and to include the cost of the most recently purchased goods in the cost of the goods sold. This assumption, of course, of course, does not agree with the actual physical movement of goods in most business organizations. 

There is, however, a strong logical argument to support LIFO. A certain size of inventory is necessary in a going concern- when inventory is sold, it must be replaced with more goods. The supporters of LIFO reason that the fairest determination of income occurs if the current costs of merchandize are matched against current sales prices, regardless of which physical units of merchandize are sold. When prices are moving either up or down, the cost of goods sold will be under LIFO, show costs closer to the price level at the time the goods are sold. Thus, the LIFO method tends to show a smaller net income during deflationary times than other methods of inventory valuation. The peaks and valleys of business cycle tend to be smoothed out. In inventory valuation, the flow of costs- and hence income determination- is more important than the physical movement of goods and balance sheet valuation.

An argument can also be made against LIFO. Because the inventory valuation on the balance sheet reflects earlier prices, it often gives an unrealistic picture of the inventory's current ratio may be distorted and must be interpreted carefully.  

Questionnaire:

• What is LIFO?
• Expand LIFO.
• Explain the advantages or uses of LIFO method in business.