Saturday, June 1, 2013

Understand cost accounting’s LIFO method

Last-in-First out method (LIFO) is method of pricing the concerns of materials. This method is based on the supposition that the items of the last batch (lot) buy are the first to be issued. Consequently, under this method the prices of the last batch (lot) are used for pricing the concerns, until it is exhausted, and almost immediately. If on the other hand, the quantity of issue is more than the quantity of the latest lot than earlier (lot) and its cost will also be taken into consideration. For the duration of inflationary period or period of growing prices, the use of LIFO would help to make sure that the cost of production determined on the above base is approximately the present one. This method is also useful particularly when there is a feeling that because of the use of FIFO or average techniques, the profits shown and tax paid are excessively high.

Benefits of LIFO method are as follows:

1. The cost of materials concerned will be either nearer to and or will replicate the current market price. Thus, the charge of goods produced will be associated to the leaning of the market price of materials. Such a tendency in price of materials allows the matching of cost of production with current sales proceeds.

2. The utilization of the method during the period of growing prices does not reflect unwarranted high profit in the income statement as it was under the first-in-first-out or standard method. In fact, the profit shown here is relatively lower since the cost of production takes into account the increasing trend of material prices.

3. In the case of lessening prices profit tends to raise due to lower material cost, yet the finished goods appear to be more competitive and are at market cost.

4. Above a period, the use of LIFO helps to iron out the variations in profits.

5. In the period of inflation LIFO will be liable to show the correct profit and thus keep away from paying undue taxes to a number of extents.

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