Inventory is an organization’s or business’s valuable assets. The rise and decrease in the stock decide the profit and rates to the companies. These businesses must keep a record and accounting checklist of their inventory to determine their sales and progress. If your stock is emptying quickly, you are making more sales, and your cost of goods sold is higher.
There are usually two methods for keeping inventory records on your financial statements; one is the FIFO, and the other is LIFO. The type of method you will use depend on the type of product you manufacture and on the nature of the business organization you run.
This article will shed light on the main difference between these two methods and how they affect the tax payables and other financial aspects.
What is LIFO, and its working?
LIFO stands for last in, first out. It is one of the accounting methods that businesses use to calculate the cost of inventory or the cost of goods sold. In the last in first out method, the stock or goods that enter at last or are new additions to the inventory are sold first. If you are having some goods already in stock and get new arrivals, then the sales you make for these products will be from the last appearances. Remember, each unit’s sales rates will differ from those already in stock for the last in first out methods.
Top 3 benefits of LIFO
There is an eternal debate on the benefits of the last in first out method over the first in first out method. Some countries and organizations use this method to manage their inventory and keep adequate account records and statements.
The following are some of the very important benefits of the LIFO method for businesses.
1. Higher Cost of goods sold (COGS)
With the LIFO methods, the cost of goods sold is higher because as soon as you receive the products or goods from the manufacturing department, you sell them first before the goods already in stock. When the inflation rates increase, you sell the received products at higher rates according to the new sales rates in the market, increasing your cost of goods sold.
2. Low taxes
As the inventor left behind is always lower than the FIFO method, you have to pay less amount of taxes. You always have a higher cost of goods sold, but the value of leftover inventory is always lower, making you pay less tax on inventory and assets. To ensure you pay the right amount on your inventory, you must make the correct entries of the cost of goods sold in your statements, hire top accounting firms in Dubai to maintain your books and account records for tax purposes.
3. Accurate income statements
As you will be well familiar with the inflation rates and sell the products according to these rates, maintaining the cost sold for each unit or item will be easier to record in the statements. Thus, LIFO methods ensure the correctness and completeness of your income statements. Your account records will not be a mix of different sales rates for the same type of products.
Top 3 disadvantages of LIFO
Some of the more dominating reasons over the LIFO methods make them less preferable for certain businesses and organizations. We call these dominating factors the drawbacks of this method.
Following are some key disadvantages that come with the last in first out method.
1. Old inventory remains unsold
In the LIFO method, there is no guarantee or chances for selling existing stock or goods. The inventory of many months and years remains in the stock for an unknown number of years and months. Not being able to sell the manufactured products is a loss for business and an increase in expenses.
2. Complex account records
When you compile account or inventory records while following the last in first out method, you always have to make entries for previous stock unless they are sold. That is why the documents become more complex and difficult to understand over time.
3. It does not work for each product
LIFO does not work for each type of product. A business manufactures various products, among which some products may be decayable and some of them not. It becomes impossible to implement different inventory record methods for each product type. LIFO is a failed method for products that are decayable.
What is FIFO, and why is FIFO less preferable?
FIFO stands for first in, first out, and the name exhibits that it is the total opposite of the LIFO method. The product or goods that enter first are the ones to leave the stock early. Some of the reasons make FIFO less preferable because they increase the tax payables as they make things look like a business is making more money.
Another drawback of FIFO is ith the increase in inflation rates, it becomes difficult to identify the actual costs leading to wrong account records; hire the best auditing firms in Dubai for dealing with cost variation issues that bring variations in the income statements and other financial documents.
Following are some drawbacks of the FIFO method.
- Higher taxes
- Difficult to identify actual costs
- Lower cash flows
Keep your balance sheets and income statements accurate for accurate tax costs
Your tax payables and returns will depend on the accounts and transaction records you will maintain. The accounts records are dependent on your sales and expenses; make sure you make these entries correct to face no tax burdens and costs. Do not hesitate to take the experts’ help in maintaining your records and financial statements as they know well to keep them updated and accurate.