Differences in LIFO, FIFO, FEFO, and Average Cost Methods
The LIFO, FIFO, FEFO, and Average Cost - Inventory methods represent the majority of trading business assets. Thus, inventory is a very important component in a company's balance sheet. This is why it is important for trade business owners or managers to know the value of their inventory.
There are four ways that are generally used by retail and wholesale business owners to manage sales and find out the value of their inventory items, namely the LIFO, FIFO, FEFO, and Average Cost methods. How do each of these methods work and what distinguishes the four? The following is a detailed explanation.
FIFO method
Differences in the LIFO, FIFO, FEFO, and Average Cost Methods In the FIFO (First In, First Out) method, items that are first entered will be sold or issued first, while items that last entered will be sold or issued later on. This method is the most common method used in inventory valuation.
The FIFO method is based on the assumption that the flow of inventory entry costs must be matched with the sales proceeds. As a result, the cost per unit of inventory entered last is used as a basis for determining the cost of goods still in inventory at the end of the period (ending inventory).
For example, a bakery produces 200 buns on Monday at a unit price of $. 10,000, and 200 more breads on Tuesday at a unit price of $. 15,000. FIFO states that if the bakery sells 200 loaves on Wednesday, the COGS (on the income statement) is $. 10,000 per bread, because this is the unit price of the first bread in inventory. Bread whose unit price is $. 15,000 will be allocated to end inventory (on the balance sheet).
Metode LIFO
The LIFO (Last In, First Out) method is a method that is inversely proportional to the FIFO method. According to this method, the last item entered will be issued or sold first, while the goods that first enter the warehouse will actually be removed or sold later on. This method aims to facilitate the process of structuring the goods, both inputting and taking inventory.
LIFO method allows companies to be able to save taxes when inflation occurs, due to small profits. In addition, operating income in the company will not affect the profit or loss of price fluctuations that occur. However, the use of this method is more complicated than other methods and the bookkeeping costs are more expensive and the resulting profit / loss is lower.
The LIFO method is no longer recognized by international accounting standards. Likewise by accounting standards applied in Indonesia. PSAK, which is a reference for Indonesian accountants in accounting, has adjusted to IFRS that is used globally.
There are three reasons why the LIFO method is ineffective to be used in valuing inventories, firstly because there is a significant difference in earnings. Compared to the FIFO and FEFO methods, the LIFO method, there is a considerable difference in the operating profit generated when using the LIFO method in estimating inventory.
Second, the LIFO method also does not represent the current level of inventory costs. This makes the value of inventory has no relevant value or the actual state. In the end this reduces the quality of the financial statements themselves. Finally, this method can also be used to manipulate taxes.
FEFO method
The FEFO method is a method in which goods with the nearest expiration period must be removed or sold first, regardless of whether the goods come first or later. The FEFO method is commonly applied by food retail stores and pharmacies. Usually, the product with the shortest expiry period will be placed in the front position so that it can be taken in advance by the customer. Products that have a long expired period will usually be stored in a warehouse first.
Average Cost Method
The Average Cost method is the midpoint or a combination of the FIFO and LIFO methods. In this method, goods that will come out are recorded based on the average price of the goods. To get the average cost of goods (weighted average), the total initial balance of goods to be sold or merchandise is added to the total total purchase of merchandise, then divided by the total quantity of merchandise purchased, then added to the quantity of initial balance of merchandise.
Automatically calculate stock value
Calculating stock values requires high accuracy. Because miscalculations can cause harm to your business, we recommend that you use inventory management software that allows you to automatically calculate stock values. This tool makes it easy for you to carry out inventory assessments using different methods including FIFO, FEFO, and Average Cost, of course with a high degree of accuracy.