Fifo & LIFOAbhay TyagiSaketAbhinav Tyagi

Lesson objectivesBy the end of the lesson students should be able to: -Understand the ways businesses value stock on the balance sheetKnow the term FIFO and LIFO

Stock valuationFor many businesses, stocks (or inventories) represent a significant proportion of assets so must be accurately recorded on the balance sheet.Stock valuation is the technique used to measure the value of raw materials, work-in-progress or finished goods.Stock valuation is important when stocks are difficult to distinguish in terms of purchase date and cost.

For exampleCrude oil prices change on a daily basisIt is difficult to distinguish between different batches of stocks.This means a firms inventories will consist of different batches of deliveries valued at different purchase costs

MethodsThere are two main methods of stock valuationLIFO Last In First OutFIFO First In First Out

Last In First OutThis methods involves using the most recent batches of stocks first.It is a suitable method for businesses that do not need to adhere to a sell by date.The result is the older stock, which is usually valued at a lower cost will remain the same. I.e. the closing stock will be a lower value.Businesses that use LIFO tend to have big inventoriesThis will result in tax benefits as although there is no fundamental difference in the business the gross profit figure will be lower

LIFO ContCost of goods sold = opening stock+ purchases- closing stock

Therefore a lower valued closing stock will mean a higher cost of goods sold.

Gross profit = Sales Revenue- COGS

Therefore lower gross profit and subsequently lower corporation tax payable

LIFO Cont

DateStock boughtStock issuedStock leftStock valuation1st March30 Units @ $25 p/u30 x $25$7505th March20 Units @ $25 p/u10 x $25$2508th Match20 Units @ $30 p/u10 @ $2520 @ $30$250$600$85010th March15 units @ 30 p/u10 @ $255 @ $30$250$150$400

Table what it means!At the begging of March the form bought 30 units of stock at $25 each, therefore the stock valuation is $750Four days later 20 units were needed for production, so there was 10 units left, valued at $250On 8th March the form paid the supplier for another 20 units, however they now cost $30, giving a valuation of 600, which is then added to the $20 giving $850On 10th March 15 units are issued for production. LIFO means all 15 units are values at $30 (the most current cost value). This leaves 5 left, $150, added to the unused batch of earlier stock, $400The total value of stocks equals $1350, $750 on 1st March and another $600 on 8th March

First In First OutThis is a method of stock valuation whereby stock is valued based on the order in which it was purchased by the business.This method ensures that any unsold stock is more realistically valued as its current or replacement stock is valued at the most recent purchase cost.It is suitable for business that regularly rotate their stocks.On the balance sheet it is a more realistic and representative of the current market value. It will boost the gross profit

FIFO Cont

DateStock boughtStock issuedStock leftStock valuation1st March30 Units @ $25 p/u30 x $25$7505th March20 Units @ $25 p/u10 x $25$2508th Match20 Units @ $30 p/u10 @ $2520 @ $30$250$600$85010th March10@ 25 p/u5 @ 30 p/u15 @ $30$450$450

Choosing between LIFO and FIFOIf there were no price increases over time LIFO and FIFO would get the same results, however the reality prices increase due to inflation.Laws are in place to stop firms switching between FIFO and LIFO, the same has to be used when account presented to the government and the shareholdersIn UK and Canada LIFO is not permitted for tax but it is in USA

TaskUsing LIFO and FIFO construct a Profit and Loss Account to show the effects on the firms trading profit. The market price is $20 per unitOpening stock in Jan = 1000 units at $9000 each, giving a total of 4000 units in theGiven time period

MonthStocks purchased (units)Cost p/u ($)Stocks issued (units)Value of stock purchasedJanuary100010100010000February100011100011000March100012100012000Total300033000

HomeworkCrystal Arts is a producer of expensive chandeliers. Each chandelier sells for 1000. During this month the firm has taken orders for 15 chandeliers. It has 10 units as opening stock, purchased at a cost of 500 each. Crystal arts replenishes its stock by ordering another 10 units, but inflation has raised costs to 600 per unit. Operating expenses are 1000 per month and the rate of corporation tax is 30%Define the term opening stock [2 marks]Using both FIFO and LIFO methods of stock valuation, construct a simplified profit and loss account for Crystal Arts to show the effects on gross profit and net profit. [ 8 marks]