Basis for Selection of Inventory
Method
(Which is the Best Inventory
Valuation Method):
Learning objectives of this article:
-
How to select an inventory valuation method
among various methods. (average, LIFO, FIFO).
How
does one chose among the various inventory methods(
Average, LIFO, FIFO). Although no absolute rules can
be stated, preferability for LIFO can ordinarily be
established in either of the following
circumstances:
-
If
selling prices and revenues have been
increasing. faster than costs, thereby
distorting income.
-
In
situations where LIFO has been traditional, such as
department stores and industries where a fairly
constant "base stock" is present such as refining
chemicals and glasses.
Conversely
LIFO would not be appropriate:
-
Where
prices tend to lag behind costs.
-
In
situations where specific identification is traditional,
such as in the sale of automobiles, farm equipment, art,
and antique jewelry.
-
Where unit
cost tend to increase as production increases, thereby
nullifying the tax benefit that last in first out (LIFO)
method might provide.
Tax
consequences are another consideration, Switching from FIFO
to LIFO usually results in an immediate tax benefit.
However, switching from LIFO to FIFO can result in a
substantial tax burden.
Often the
inventory valuation methods are used in combination with
other methods. For example, most companies never use LIFO
totally, but rather use it in combination with other
inventory valuation approaches. One reason is that certain
product lines can be highly susceptible to deflation instead
of inflation. In addition, if the level of inventory is
unstable, unwanted inventory liquidations may result in
certain product lines if LIFO is used.
Finally, where
inventory turnover in certain product lines is high, the
additional recordkeeping and expense are not justified by
FIFO. Average cost is often used in such cases because it is
easy to compute.
It is
recommended that the pricing method most suitable to a
company be selected and, once selected, be applied
consistently thereafter. If conditions indicate that the
inventory pricing method in use is unsuitable, serious
considerations should be given to all other possibilities
before selecting another method. Any change should be
clearly explained and its effect disclosed in the financial
statements. Relevant Articles:
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