Question

what's the advantages of LIFO

Answer 1

Advantages of LIFO(Last in First Out Inventory System)

LIFO is based on the principle that the latest inventory that was purchased will be the first to be sold. It is permitted under US GAAP but prohibited under IFRS yet it has advantages mentioned below-

1. LIFO Method provides a better measurement of current earnings by matching most recent costs against current revenues It results in reduction of understatement of cost of goods sold (COGS) and overstatement of profit. Therefore the quality and reliability of earnings are improved under LIFO.

2. When LIFO is used in the periods of inflation, the current purchases at higher prices are matched against revenues that alleviate the overstatement of profit and therefore reduce income tax bill. The reduction in income tax results in improvement of cash flows of the company.

3. LIFO minimises the write down to market as the companies using LIFO method do not have much inventory at current higher prices because, under this method, most recent inventory purchased at higher price is sold first. So the chances of write-downs to market in future due to decline in inventory prices are minimized or even eliminated under LIFO.

4. LIFO proves beneficial in pricing decisions especially if entity is using cost plus pricing. As cost of units sold is determined on the basis of most recent purchase cost therefore, prices determined on such costs will help recover material cost in a better way unlike FIFO where prices are based on costs that may be too low thus putting entity at risk for not recovering material costs.

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