Question

The owner of the business Nevis Stationary and Supplies, Neville Heaven, has stated that his objective is to cut back on his tax liability as much as possible and at the same time have his balance sheet looking at its best and is of the view that the LIFO method would be best to achieve both. Do you agree with Neville? Explain your answer clearly distinguishing between the first in, first out (FIFO) and last in, first out (LIFO) methods of inventory valuation, with reference to IAS 2.

Answer 1

FIFO is first in and first out method of inventory valuation that values the cost of goods based on the inventory that is received first among the lots. Similarly, LIFO calculates the cost of goods sold basis the last lot of inventory received. As per IAS 2, inventory has to be valued at lower of cost of net realizable value. And the cost as per IAS 2 has to be measured as per FIFO or weighted average cost. Also, IRS requires tax payers to value inventory as per FIFO. The reason behind IRS preferring FIFO is that it shows higher profits than LIFO since the cost of goods sold is lesser. Also, IAS prefers FIFO since the goods bought in first tend to loose value over time and may result in irrational profits if accounted for later in time.

Hence, going by the tax rules and accounting standards it will be impractical for the owner to adopt LIFO although it may cut his tax liability and make the balance sheet look good.