LIFO Advantages and Disadvantages

The LIFO valuation method has certain advantages, namely elimination of inventory profits, reduction of federal income taxes, and improved cash flow. Likewise, it has disadvantages:

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LIFO cost could exceed market value if costs were to decline.

y

The LIFO valuation method is complex and costly to apply.

y

LIFO distorts crucial ratios, such as the current and debt-to-worth ratios and inventory turnover.

y

LIFO is an end-of-year calculation. Therefore, reliability of interim statements is questionable because a company must forecast prices for the remaining accounting year and estimate yearend inventory quantities.

y

Balance sheet inventory is costed at noncurrent unit costs. LIFO Reduces earnings It Understated inventory It does not approximate physical flow It creates distortion of income when old layers eliminated It creates Distortion of buying habits (avoid liquidation of old layers)

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