FIFO and LIFO (Essay Sample)

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FIFO and LIFO
FIFO and LIFO are methods of valuation of inventories, which have a direct impact on the income statement, cash flow statement and the balance sheet. FIFO stands for first-in first out while LIFO stands for last-in first-out. FIFO is an inventory control strategy, which assumes that the items that are purchased or produced first are the first to be sold (Charles, 2012 page 236). However, it does not mean that the oldest item is sold first but it is recorded as sold. An example is a company that receives 100 widgets in July and 150 widgets in August and sells 200 widgets in September, including 100 widgets received in August. LIFO is an inventory management strategy whereby the most recent item is recorded to be the first to be sold. During inflation, LIFO results into larger costs of sales that have a tendency of reducing the taxable income and hence reducing the tax. An example is a company that receives 100 widgets in July and 150 widgets in August and sells 200 widgets in September, including 50 widgets received in July. The difference between the value of the inventories computed by LIFO and FIFO techniques is known as the LIFO reserve (Warren et al, 2012 page 295).
The company I chose for this topic is the Target Corporation. The corporation offers discounted merchandise products to the market. They offer the everyday essentials and the fashionable material to the customers. The annual 10-k annual reports contain the financial information that can depict the utilization of the LIFO or FIFO inventory management techniques. The financial statements of this company depict that their current fiscal year ended on February 2, 2013. The financial statements as at this date depict the use of the LIFO inventory management techniques. Most of the inventories of the corporation are accounted for by the retail inventory accounting method using the last in first out management technique. The old inventories are left to accumulate while the new inventories are sold into the market.
The costs of the inventories the corporation incurs include the payments to suppliers for inventories, freight costs of shipping of the goods to the market, and the import costs. The inventory value is adjusted regularly to depict the market conditions. The shrink benefit is based upon the historical losses that are verified by the physical inventory counts. However, the changing economic situations affect the corporation inventory valuation. The economic changes include the change in the consumer demands, inflation, increasing competition and the changing guest preferences. According to the financial statements, the risks are largely mitigated because the inventories depict a turnover for every three months. As at February 2, 2013, the total inventories were valued at $ 7903000.
The costs of sales also include the markdowns, payment term cash discounts, distribution center costs, and import costs. The inventory costs and the gross margins are calculated using the cost to retail ratio. The application of the RIM results in the reduced valuation of the inventories because the permanent markdowns reduce the value of inventories. Therefore, this has an effect of reducing the value of the inventories by increasing the cost of sales. This has an effect of decreasing the taxation to the company compared to 2011 fiscal year. This is caused by the increased cost of sales and thus causing a decreased amount of taxable income and hence decreased taxes. The LIFO technique used by the corporation, therefore, has an effect on the balance sheet by devaluing the inventories.
The corporation value is reduced compared to when they would have used the FIFO technique. Therefore, the possibility of the company acquiring loans is reduced. I think the company utilizes this method to increase the earnings of the corporation using the reduction in taxation and hence valuation of returns. From the financial data, the earnings per share are elevated in the fiscal year 2012. This has the short-term effect of increasing the cost of sales but a long-term effect of increasing their income. The company viability at the stock market is likely to increase since their earnings per share are elevated. Therefore, the value of the corporation is likely to increase.
Advantages of using LIFO over FIFO
The LIFO technique is an essential method if the corporation has an aim of reducing the taxes impounded to the taxable income. The cost of sales is likely to be increased and hence the taxable income reduces (Charles, 2012 page 236). The taxation on the reduced taxable income will also reduce. Upon better financial analysis, the expenses of the corporation will reduce and hence a probable increase in revenues. LIFO is also a good indicator of the current market situation. The method is also advantageous during deflation due to the reduced cost of sales. This has an effect of increasing inventories.
Disadvantages of LIFO over FIFO
LIFO is subject to many restrictions from the GAAS and IFRS compared to the FIFO, which has fewer restrictions. These are part of the USA...