Accounting For Inventory – FIFO and LIFO Methods

Fifo lifo system of managing inventory

Every business owner should understand how the basics of accounting for inventory takes place. Although you will probably not be able to go through these calculations accurately without the help of a business account, you should be aware of the two basic methods that are used to calculate the value of inventory. Evaluating inventory for the business can be a complicated and complex process. These are the two basic methods used for for inventory accounting are LIFO (Last In First Out) and FIFO (First In First Out).

LIFO, Last in First Out. This accounting method values the inventory on the cost and price of the merchandise that is the newest. This form of accounting and calculating the worth of an inventory was brought into place when inflation became common. Under this system, the merchandise that is the newest and received most recently by the business is sold first. For example, let us say you purchased a business product that the value of $30 for unit last year. You again purchased this same merchandise this year but then the price had gone up to $50 per unit. Under the LIFO method, the merchandise that you purchase this year at a cost of $50 per unit will be sold first.

FIFO, under this method the inventory is valued against the oldest product in the stock. This was traditionally the method used by most businesses to account for inventory and to calculate its value. This method was common before inflation became commonplace.  So taking the same example as above, your entire merchandise inventory would be valued at $30 a unit because that is the price of the oldest unit in your stock. This method has a way of confusing accounting figures when there is inflation. Since there is a huge difference in the price of the merchandise from last year today, the evaluation of the inventory can be misleading. Under FIFO for system, the merchandise that was received first is sold first.

Your business can follow either of these methods depending upon the nature of your business product and what suits your business more. You can use the both dollar system or the unit system to calculate inventory value.

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