The advantages and disadvantages of FIFO, LIFO, and weighted average
Every company's goal is to make as much profit as possible and to do so there are
a number of different aspects each company must look at to make sure that they are doing this. One aspect that they can control is their inventory and the way they buy it store it and sell it. There are three different ways that a company can calculate their inventories: First in First out (FIFO), Last in First out (LIFO), or the weighted average method. All of these methods are approved by GAAP and it is important for each company to find which one will most benefit them. Which way would give each company the most profit and show where the company where their money is spent and where it could be saved more. For a company to decide which would most benefit them we must first understand how each inventory method works.
The first method is referred to as FIFO, this simply means that the items that were purchased first by the firm are sold first. So any items bought at the beginning of the month are sold before items that might be bought in the middle of the month. As stated before there are times that different companies should use FIFO instead of any of the other. For example in the times of inflation it will allow the firm to use the lowest cost of good sold. This in turn will allow the company to make more money in this time period because it is getting rid of the items at a lower cost then if they used LIFO because inflation has caused their costs to go up as well as the price of their raw materials.
The second method that firms choose is LIFO. This method rather than taking the items purchased first takes the items last and send them out first. So if we are shipping out items at the end of the month we would use the items that were most recently purchased. Although there is not really deflation in the world this way could be beneficial when there is a very low interest rate and the price of the product is rising quickly. As stated before there are certain firms that should use certain methods and that is the same for this one. Although there are not many firms that use this method because most of the time it actually increases their cost for goods.
The last inventory method is weighted average and this is done by taking the average of all the costs of the items bought within a given time period. This can be used in industries that have a lot of price change because it will average the prices out to keep the overall price of the cost of goods sold down.
GAAP approves three different methods of how to inventory a firms goods, which allows companies to determine which one will work best for them and make the most money. So firms need to keep aware of different and changing prices, inflation and their own goods to make sure that they make as much money as possible.
The advantages and disadvantages of FIFO, LIFO, and weighted average
By: Sean Davies
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