FIFO & LIFO : FIFO & LIFO IB Business & Management
IB2 Higher Level Lesson objectives : Lesson objectives By the end of the lesson students should be able to: -
Understand the ways businesses value stock on the balance sheet
Know the term FIFO and LIFO Stock valuation : Stock valuation For many businesses, stocks (or inventories) represent a significant proportion of assets so must be accurately recorded on the balance sheet.
Stock valuation is the technique used to measure the value of raw materials, work-in-progress or finished goods.
Stock valuation is important when stocks are difficult to distinguish in terms of purchase date and cost. For example : For example Crude oil prices change on a daily basis
It is difficult to distinguish between different batches of stocks.
This means a firm’s inventories will consist of different batches of deliveries valued at different purchase costs Supermarkets : Supermarkets In supermarkets it is difficult to distinguish between different batches of the same product.
Supermarkets use a stock rotation system whereby the newest stocks go to the back of the shelves to ensure the older batches are bought first.
This is particularly important for perishable goods.
There are two main methods of stock valuation
LIFO Last In First Out
FIFO First In First Out Last In First Out : Last In First Out This methods involves using the most recent batches of stocks first.
It is a suitable method for businesses that do not need to adhere to a sell by date.
The result is the older stock, which is usually valued at a lower cost will remain the same. I.e. the closing stock will be a lower value.
Businesses that use LIFO tend to have big inventories
This will result in tax benefits as although there is no fundamental difference in the business the gross profit figure will be lower LIFO Cont… : LIFO Cont… Cost of goods sold = opening stock+ purchases- closing stock
Therefore a lower valued closing stock will mean a higher cost of goods sold.
Gross profit = Sales Revenue- COGS
Therefore lower gross profit and subsequently lower corporation tax payable LIFO Cont… : LIFO Cont… Table what it means! : Table what it means! At the begging of March the form bought 30 units of stock at $25 each, therefore the stock valuation is $750
Four days later 20 units were needed for production, so there was 10 units left, valued at $250
On 8th March the form paid the supplier for another 20 units, however they now cost $30, giving a valuation of 600, which is then added to the $20 giving $850
On 10th March 15 units are issued for production. LIFO means all 15 units are values at $30 (the most current cost value). This leaves 5 left, $150, added to the unused batch of earlier stock, $400
The total value of stocks equals $1350, $750 on 1st March and another $600 on 8th March First In First Out : First In First Out This is a method of stock valuation whereby stock is valued based on the order in which it was purchased by the business.
This method ensures that any unsold stock is more realistically valued as its current or replacement stock is valued at the most recent purchase cost.
It is suitable for business that regularly rotate their stocks.
On the balance sheet it is a more realistic and representative of the current market value.
It will boost the gross profit FIFO Cont… : FIFO Cont… Comparing… : Comparing… The closing stock values
If revenue is $1750. The impact on profits would be
Sales 1750 1750
Purchases 1350 1350
Closing stock 400 450
Gross Profit 800 850 Choosing between LIFO and FIFO : Choosing between LIFO and FIFO If there were no price increases over time LIFO and FIFO would get the same results, however the reality prices increase due to inflation.
Laws are in place to stop firms switching between FIFO and LIFO, the same has to be used when account presented to the government and the shareholders
In UK and Canada LIFO is not permitted for tax but it is in USA Task : Task Using LIFO and FIFO construct a Profit and Loss Account to show the effects on the firm’s trading profit. The market price is $20 per unit Opening stock in Jan = 1000 units at $9000 each, giving a total of 4000 units in the
Given time period Homework : Homework Crystal Arts is a producer of expensive chandeliers. Each chandelier sells for £1000. During this month the firm has taken orders for 15 chandeliers. It has 10 units as opening stock, purchased at a cost of £500 each. Crystal arts replenishes its stock by ordering another 10 units, but inflation has raised costs to £600 per unit. Operating expenses are £1000 per month and the rate of corporation tax is 30%
Define the term opening stock [2 marks]
Using both FIFO and LIFO methods of stock valuation, construct a simplified profit and loss account for Crystal Arts to show the effects on gross profit and net profit. [ 8 marks]