![]() ![]() For example, the following is the comparison between LIFO (Last In, First Out) and FIFO (First In, First Out):ĭuring periods of rising prices and stable or growing inventories:ĬOGS and Income. The choice of inventory system or method affects financial numbers. A company may attempt to manipulate its net income at the end of the year simply by altering its pattern of purchases. The income tax problem is particularly severe when involuntary liquidation results from a strike or a shortage of materials in these situations, companies may incur high tax bills when they can least afford to pay taxes. ![]() If the base or layers of old costs are eliminated, strange results can occur, because old, irrelevant costs can be matched against current revenues. Using replacement cost is referred to as the next-in, first-out method it is not acceptable for purposes of inventory valuation. LIFO falls short of measuring current cost (replacement cost) income, though not as far as FIFO. LIFO does not approximate the physical flow of the inventory items except in particular situations. It makes the working capital position of the company appear worse than it really is. LIFO may have a distorting effect on a company's balance sheet. However, non-LIFO earnings are now highly suspect and may be severely penalized by Wall Street. Many managers would just rather have higher reported profits than lower taxes. Since the most recent inventory is sold first, there isn't much ending inventory sitting around at high prices, vulnerable to a price decline. With LIFO, a company's future reported earnings will not be affected substantially by future price declines. This is related to tax benefits, because taxes must be paid in cash. "Whatever is good for tax is good for financial reporting." As long as the price level increases and inventory quantities do not decrease, a deferral of income tax occurs. These are the major reason why LIFO has become popular. Current costs are matched against revenues and inventory profits are thereby reduced. Again, the analyst should compare the firm's revenue growth with that of the industry to assess the situation. An extremely low inventory turnover value implies capital is being tied up in inventory and could signal obsolete inventory.Revenue growth should be compared with that of the industry to assess which explanation is more likely. An abnormally high inventory turnover and a short processing time could mean either effective inventory management or inadequate inventory, which could lead to outages, backorders, and slow delivery to customers (which would adversely affect sales).The lower the ratio, the longer the time between when the good is produced or purchased and when it is sold. This ratio can be used to measure how well a firm manages its inventories. Inventory turnover measures how fast a company moves its inventory through the system. GAAP the change is accounted for prospectively and there is no retrospective adjustment to the financial statements. The one exception is for a change to the LIFO method under U.S. If a company changes an inventory accounting policy, the change must be justifiable and all financial statements accounted for retrospectively. This information can greatly assist analysts in their evaluation of a company's inventory management.Ĭonsistency of inventory accounting policy is required under both U.S. Financial statement disclosures provide information regarding the accounting policies adopted in measuring inventories, the principal uncertainties regarding the use of estimates related to inventories, and details of the inventory carrying amounts and costs. ![]()
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