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Search for:. Recent Posts Opening stock vs closing stock Appraise vs apprise Assume vs presume Council vs counsel Consignment vs sale. FIFO Method. Primary distinction. The earliest inventory received will be excluded from the business first and the cost will be allocated in accordance. The inventory will be excluded from a business based on an average cost of all goods present in a business. Impact on financial figures. One disadvantage of the specific identification method is that it permits the manipulation of income.
For example, assume that a company bought three identical units of a given product at different prices. The units are alike, so the customer does not care which of the identical units the company ships. Which is the correct method? All four methods of inventory costing are acceptable; no single method is the only correct method.
Different methods are attractive under different conditions. If a company wants to match sales revenue with current cost of goods sold, it would use LIFO. If a company seeks to reduce its income taxes in a period of rising prices, it would also use LIFO.
On the other hand, LIFO often charges against revenues the cost of goods not actually sold. Also, LIFO may allow the company to manipulate net income by changing the timing of additional purchases. The FIFO and specific identification methods result in a more precise matching of historical cost with revenue.
However, FIFO can give rise to paper profits, while specific identification can give rise to income manipulation. The weighted-average method also allows manipulation of income. Only under FIFO is the manipulation of net income not possible. Generally, companies use the inventory method that best fits their individual circumstances.
However, this freedom of choice does not include changing inventory methods every year or so, especially if the goal is to report higher income.
Continuous switching of methods violates the accounting principle of consistency, which requires using the same accounting methods from period to period in preparing financial statements. Consistency of methods in preparing financial statements enables financial statement users to compare statements of a company from period to period and determine trends. If we switch inventory methods, we must restate all years presented on financial statements using the same inventory method.
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