Inflationary
situations create distortion in reporting inventory in financial
statements. For instance, two units bought at different periods of time
and sold for same price, earn different profit margins.
Thus
during periods of rising prices, the FIFO method does not give users of
financial statements a current picture of profit-future of the company.
LIFO
In
LIFO, we sell a unit bought recently (say, @20) for Rs. 30 per unit),
while the unit bought for Rs. 10/- is still in stock! So the inventory
shows that item (now costing Rs 20 in open market) at Rs 10 each, meaning gross
under valuation of inventory.
Graphical Comparison
-Companies under FIFO system pay more taxes (because they
‘show' more profit).
-Those opting for LIFO ‘show' less profit pay less tax and
have more cash.
-Otherwise, everything is exactly the same.
Companies
whose inventories costs (values) are rising, (inflation) benefit from
LIFO.
These
whose stock values plummet (e.g. computer chips) had better opt for FIFO.
Commodities
dealers should go for ‘Weighted Average' method.