Inventory is the asset for the company or business.

Inventories are calculated at the end of the

year by the formula

Beginning inventory + purchases- cost of good sold= closing inventory

The accounting method that a company decides to determine the cost of inventory can directly

impact the asset, income statement & statement of cash flow.

In LIFO method assumes that the last unit that makes its way into inventory is the one which is

sold first .During the period of rising inventory cost & stable output LIFO isn’t good indicator of

ending inventory valuation because the valuation is much lower than today ‘s price (Rao, P. M.

2011). LIFO result in lower income & increase cost of good sold .i.e. decrease in total assets.

Let's use the gasoline industry as an example. Let's say that a tanker truck delivers 2,000 gallons

of gasoline to Henry's Service Station on Monday and the price at that time is $2.35/gallon. On

Tuesday, the price of gasoline has gone up and the tanker truck delivers 2,000 more gallons at a

price of $2.50/gallon. Under LIFO, the gasoline station would assign the $2.50/gallon gasoline to

Cost of Goods Sold and the remaining $2.35/gallon gasoline would be used to calculate the value

of ending inventory at the end of the accounting period.

In FIFO method assumes that the primary unit that makes its way into the inventory is the

primary one sold. During the period of rising stock cost & solid output rate it gives us the better

indication of ultimate stock (Subramanyam, K. R. (2014). It'll increase the assets (the inventory

at excessive price) but it also grow the net income. Going back to the gasoline industry example,

under FIFO, the gasoline station would assign the $2.35/gallon gasoline to Cost of Goods Sold

and the remaining $2.50/gallon gasoline would be used to calculate the value of ending inventory

at the end of the accounting period.

Therefore in case of increasing inventory cost & stable output price FIFO is the best method of

inventory valuation. On the other hand if the cost of inventory declining with stable output price

in that situation LIFO is the best indicator of inventory valuation. It shows the high cost of good

sold resulted in low cost of inventory. As the result the total assets of the company decline & the

total income also decline. It shows the cost of good sold at the current prices. Thus in this

situation LIFO is better than FIFO.

Reference

Rao, P. M. (2011). Financial Statement Analysis and Reporting. New Delhi: PHI Learning Pvt.

Ltd.

Subramanyam, K. R. (2014). Financial Statement Analysis (Eleventh ed.). New York: McGraw

Hill.