COMPARATIVE STUDY ON FIFO, LIFO AND AVERAGE COST.

FIFO:
First in, frst out, usually regarding the sale of stock. Unless
otherwise specifed, the specifc shares sold in an account will be the
frst shares that were bought. Fiscal year A 12 month accounting
period.
Under the FIF method, the cost of the earliest goods purchased are
the frst to be recogni!ed as cost of goods sold. Assuming an
in"ationary economy, this method of in#entory tracking will pro#ide
the highest gross proft for the period. At the same time this method
also states that the remaining in#entory was purchased at the highest
price le#el. For Instance$ If a whole seller follows FIF method, he will
start to sell his proudct from those units which are bought frst and
which are supposed to be frst in#entory in his business.
Advantages o FIFO Met!od
In period of rising price, FIF produces a higher net income.
%he #alue of the closing stock on the balance sheet comprises
more current costs than if &A'( or )IF is used.
%he cost "ow appro*imates the actual physical stock
mo#ement. %herefore, the #alue of the closing stock re"ects the
current replacement cost.
Unreali!ed profts or losses will not occure, i.e.increases in stock
#alues due to in"ation.
%his statement of standard accounting practice prescribe that
stock should be #alued at the lower of cost or net reali!able
#alue.
D"sadvantages o FIFO Met!od
It does not match recent costs with current re#enues as well as
)IF does
+uring periods of in"ation, the reported profts include holding
gains and normal operating profts. It yields a higher ta*able
income than the )IF and &A'( methods.
It does not assist in f*ing the selling price because it may
result in an unrealistic pricing structure.
+oesn,t minimi!e ta*es, so there will be less cash a#ailable for
use in the business.
LIFO:
)IF method assumes that the latest goods purchased are
the frst to be sold. Under )IF, the cost of goods sold is based upon
the cost of material bought towards the end of the period, resulting
in costs that closely appro*imate current costs. %he in#entory,
howe#er, is #alued on the basis of the cost of materials bought
earlier in the year. +uring periods of in"ation, the use of )IF will
result in the highest estimate of cost of goods sold among the three
approaches, and the lowest net income. For
Instance$ If a whole seller follows )IF method, he will start to sell his
proudct from those units which are bought last and which are supposed
to be last in#entory in his business.
Advantages o LIFO Met!od
-e"ects current costs . /inimi!es ta*es in in"ation, so more
cash a#ailable for use in the business.
If price are falling FIF will report the lowest net income and
)IF the highest.
It matches current re#enue with more recent costs, and gi#es
more accurate normal operating profts.
+uring periods of in"ation, it yields a lower reported income
than FIF and &A'( 0weight a#erage cost1 methods.
It pro#ides a more realistic basis for price determination.
D"sadvantages o LIFO Met!od
%he in#entory represents the earliest ac2uisition costs. +uring
periods of in"ation, the #alue of the closing stock may be well
below the current cost of replacement. %hus, it is an unrealistic
measure of current assets on the balance sheet.
It is complicated to be used when a company has many
di3erent products.
%he reported profts may "uctuate widely o#er time. &hen the
stock is e*hausted, the earliest costs 0usually the lowest costs1
are matched with the current re#enues. It may result in a
periodic peak in profts.
4asy to manipulate and it produces bad ending in#entory
#aluation. also physical "ow is unrealistic
Ave#age Cost:
%he a#erage cost method assumes that the goods
a#ailable for sale ha#e the same 0a#erage1 cost per unit. Under this
method, the cost of goods a#ailable for sale is allocated on the basis of
the weighted5a#erage unit cost. A sample computation 6a#erage unit
are as follows.
Cost o Goods Ava"$a%$e o# Sa$e Tota$ &n"ts ava"$a%$e Fo# Sa$e 'e"g!t(
Ave#age Un"t Cost
)*+,,,, - *,,,, .
)*+.,,
Advantages o 'e"g!t Ave#age Cost Met!od
It assigns an e2ual unit cost to each unit of stock
It reduces the proft and loss "uctuations.
%he #alue of the closing stock tends to approach the
replacement cost.
D"sadvantages o 'e"g!t Ave#age Cost Met!od
It does not match recent costs with current re#enues as well as
)IF does.
%he closing stock does not re"ect the current replacement cost
as under FIF.
It is more complicated to apply than the FIF and )IF
methods.

Un"t so$d /0, At )+,
)*01,,

Un"ts #e2a"n"ng 3/,
Unde# F"#st("n, 4#st(o&t 5FIFO6:
Re2a"n"ng
&n"ts:
37, 8
*1.+,
3, 8 *3.0,
3/,...........
..
1,90,
1**
7,3/$
end"ng
"nvento#:

Goods Ava"$a%$e
o# Sa$e
(End"ng "nvento#:
.Cost o goods
so$d
*;,;/,
7,3/*
**,+99
Net sa$es
(Cost o Goods
So$d
G#oss Ma#g"n
)*0,1,
,
**,+99
);,*,*

Unde# Last ("n 4#st o&t 5LIFO6:
Re2a"n"ng
&n"ts:
+,, 8
*+.,,
*/, 8
*3.,,
3/,...........
+,1,,
+,31,
1,01, end"ng
"nvento#:
<Ite2s Un"t Cost Tota$ Cost
=eg"nn"ng "nvento#:
P&#>!ase <*
P&#>!ase <+
P&#>!ase <3
Goods Ava"$a%$e o# sa$e
+,,
1,,
3,,
37,
*,+7,
)*+.,,
*3.,,
*3.0,
*1.+,
)+,1,,
7,+,,
1,**,
1,90,
)*;,;/,
..
Goods Ava"$a%$e
o# Sa$e
(End"ng "nvento#:
.Cost o goods
so$d
*;,;/,
1,01,
**,91,
Net sa$es
(Cost o Goods
So$d
G#oss Ma#g"n
)*0,1,
,
**,91,
)7,1;,
Unde# 'e"g!ted ave#age:
*;,;/,-*,+7, . )*3.311 8 3/, . )7,,0* end"ng "nvento#:
Goods Ava"$a%$e
o# Sa$e
(End"ng "nvento#:
.Cost o goods
so$d
*;,;/,
7,,0*
**,;,9
Net sa$es
(Cost o Goods
So$d
G#oss Ma#g"n
)*0,1,
,
**,;,9
)7,09*
SUMMARY OF T?REE MET?ODS
G#oss Ma#g"n
End"ng Invento#:
FIFO
);,*,*
)7,3/*
'.Avg.
)7,09*
)7,,0*
LIFO
)7,1;,
)1,01,
As you can see, the analysis is di7cult and the decision as to whether
to use FIF, )IF, or some a#erage needs to be carefully analy!ed. All
are legal$ howe#er, you need to be wary about which method you use
based on the ad#antages and disad#antages discussed abo#e.