Computerized accounting systems allow one to choose the method of costing inventory. The two most common methods are FIFO (first in, first out) and LIFO (last in, first out).
Most businesses utilize FIFO as it represents the truest evaluation of inventory. Every time an item is received into stock, the computer stamps the date and unit cost. It keeps track of it until the quantity received at that date stamp has been exhausted. If one receives stock of the item multiple times before it is sold or used in the manufacturing process, one will be able to see the variations on the cost of items on hand from purchase to purchase. When one sells the item, it will use the oldest time stamp to relieve from inventory and assign the cost of that purchase as the cost of sale.
For example: item XYZ sells for 5.00 each. The oldest date stamp
still in stock shows it is purchased at a cost of $3.00 each. There may be more recent purchases at $3.25 each, but the cost of goods sold for the sales transaction is $3.00 when using FIFO. Even if the cost is higher on the older dated transaction than on more recent purchases, it still uses the oldest date still in stock.
On an inventory valuation report, the extended total of all dated records for an item that correspond to what is on hand is its value when using either the FIFO or LIFO method. If using average cost method, the computer will grab the calculated average unit cost and extend it against the on hand to determine its valuation. This reporting method is useful when looking more at the big picture than exact numbers.
LIFO is used by some businesses who determine that the recent cost of an item reflects the most reasonable value especially in times of inflationary price pressure. The IRS, however, does not allow a business to switch back and forth between LIFO and FIFO to suit their pleasure.
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