what is lifo and fifo methods in inventory management?


3 Answer(s)


They are accounting techniques used for inventory management.

FIFO stands for First in, first out. Where the oldest inventory items are recorded as Sold first.

LIFO stands for Last in, First out. Here the recently produced items are recorded and sold first.

When we purchase goods it usually is at different times. This means that there will be many purchasing lots each of which may have different prices because during a year prices tend to fluctuate.

So it means that in our inventory there are different COST LAYERS (remember this term because it is the exact description). For e.g. Ashwin & Sons dealing in mobile phones purchase NOKIA Asha Series phone at the following dates:

30.04.2013 1000 phones @ Rs.5,000/- each = Rs.5,000,000
01.08.2013 2000 phones @ Rs.6,000/- each = Rs.12,000,000
31.12.2013 5000 phones @ Rs.7,000 each = Rs.35,000,000
Suppose also that Ashwin & Sons sold NOKIA Asha Series phones on the following dates :

01.06.2013 2000 phones sold to Rohit Telecom
15.06.2013 3000 phones sold to Rohit Telecom

Based on the above information how will you value closing inventory?? This is where FIFO and LIFO come to our rescue. FIFO assumes that the stock items (in our case they are phones) purchased first are sold first. LIFO assumes that the items purchased latest are sold first.

So the Value of Closing Inventory of Ashwin & Company, if FIFO is used, will be calculated like this:

For the 2000 phones sold on 01.06.2013 FIFO assumes that
1000 phones purchased on 30.04.2013 are sold first and
1000 phones purchase on 01.08.2013 are sold next, THEN

For the next 2000 phones sold on 15.06.2013 FIFO assumes that
1000 phones purchased on 01.08.2013 are sold first and
1000 phones purchase on 31.12.2013 are sold next, SO

Ashwin & Company ending balance of Stock or Inventory is calculated as
4000 phones from the last cost layer (Rs.7,000 each cost layer) therefore = 4000 phones x Rs.7,000 = 28,000,000

for LIFO you will do the exact opposite to arrive at the closing stock value. It will be:
1000 phones @ Rs.5,000
2000 phones @ Rs.6,000 and
1000 phones @ Rs.7,000
so ending value of Stock as per LIFO will be = 5,000,000 + 12,000,000 + 7,000,000 = 24,000,000. why is this?? because LIFO assumes that the 4000 phones sold were from the last purchasing lot (of 5000 phones), that's why only 1000 phone are taken from that lot for ending balance calculation purposes.

Hope that answers your question.

just make a correction here. I have wrongly mentioned 3000 phones sold on 15.06.2013. please change that to 2000 phones. thanks!