LIFO & FIFO HL BUS MGT

Lesson objectives By the end of the lesson students should be able to: - – Understand the ways businesses value stock on the balance sheet – Know the term FIFO and LIFO

Stock valuation  For 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 example Crude oil prices change on a daily basis It is difficult to distinguish between different batches of stocks. This means a firm’s inventories will consist of different batches of deliveries valued at different purchase costs

Supermarkets  In supermarkets it is difficult to distinguish between different batches of the same product.  Supermarkets use a stock rotation system whereby the newest stocks go to the back of the shelves to ensure the older batches are bought first.  This is particularly important for perishable goods.  There are two main methods of stock valuation  LIFO Last In First Out  FIFO First In First Out

Last In First Out This methods involves using the most recent batches of stocks first – Latest supply In is the First One to be sold to the c.ustomer 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 inventories This will result in tax benefits as although there is no fundamental difference in the business the gross profit figure will be lower

LIFO Cont… Cost 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 bought Stock Sold/Issue d Stock leftStock valuation 1 st March 30 $25 p/u 30 x $25$750 5 th March 20 $25 p/u 10 x $25$250 8 th Match 20 $30 p/u $25 $30 $250 $600 $ th March 15 $30 p/u $25 $30 $250 $150 $400

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

First In First Out This is a method of stock valuation whereby stock is valued based on the order in which it was purchased by the business – the first set of stock purchased from suppliers is the first set of stock sold to customers. 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 but in turn increase the tax

FIFO Cont… DateStock bought Stock issued Stock left Stock valuation 1 st March 30 $25 p/u 30 x $25$750 5 th March 20 $25 p/u 10 x $25$250 8 th Match 20 $30 p/u $25 $30 $250 $600 $ th March 25 p/u 30 p/u $30$450

Comparing… The closing stock values LIFO= $400 FIFO= $450 If revenue is $1750. The impact on profits would be LIFOFIFO Sales Purchases (Less) Closing stock COGS Gross Profit800850

Choosing between LIFO and FIFO If there were no price increases over time LIFO and FIFO would get the same results, however in 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 accounts are presented to the government and the shareholders In UK and Canada LIFO is not permitted for tax but it is in USA

Task Using LIFO and FIFO construct a Profit and Loss Account to show the effects on the firm’s trading profit. The market price is $20 per unit Month Stocks purchased (units) Cost p/u ($) Stocks issued (units) Value of stock purchased January February March Total Opening stock in Jan = 1000 units at $9 each, giving a total of 4000 units in the given time period

c) The LIFO method of stock valuation results in lower closing stock as the older, normally cheaper stock remains. Lower closing stock figure results in higher cost of sales and therefore lower gross profit.