Last-in-first out Method (LIFO Method) – This method operates is just reverse order of FIFO method. It is based on the assumption that the last materials purchased (just before the first issue of material) are the first materials issued Thus the price of the last batch of the materials purchased is used first for all issues until all units from this batch have been issued.
after which the price of the previous batch of materials purchased is used It should be noted that physical flow of materials man not conform to LIFO assumption.
This method is suitable in times of rising prices because materials will be issued from the latest consignment at a price which is closely related to the current price levels Valuing material issues at the price of the Latest available consignment will help the management in fixing the competitive selling prices of the products.
This method was first introduced in U.S.A., during the second world war to get the advantages of rising prices.
In period of rising prices, profit and tax liability under LIFO method would be lower than under FIFO method because cost will be charged at current prices which are at higher level Conversely.
In periods of falling prices, closing stock is saluted at old prices which are at higher level and thus, profit would also be higher resulting in higher tax liability.
Advantages of LIFO Method:
Following are the main advantage of this method
1. This method is also quick and simple to operate particularly when prices are fairly steady.
2. Under this method materials are charged to production at the latest prices paid.
3. Under this method, in times of rising prices, quotation of prices for company product will be safe and profitable.
4. This method like FIFO. does not result in any unrealistic profit or loss.
5. This method is easy to operate where purchase are made frequently less frequently.
6. Due to the effect of inflation in the cost of production, the reduced profit margin results in saving of lax.
Disadvantages of LIFO Method:
1. Under this method, closing stock is valued at the old prices and does not represent the current economic value.
2. This method is not realistic as it does not conform to the physical flow of materials.
3. Like FIFO method, in this method as well the material cost of similar jobs, may differ because materials were issued from different lots, and thus, at different prices. It makes comparison difficult.
4. This method is cumbersome when prices are subject to frequent fluctuations.
5. For pricing a single requisition, more than one price has often to be adopted.
6. When prices fluctuate this method becomes complicated.
Impact of LIIFO Method on Cost of Production
Following are the adopted effects of LIFO method on cost of production:
1. As the prices of the latest purchased materials are used for issue purpose, the issue price conforms to the current market prices. Consequently. the cost production also reflects to the current market price.
2. In a rising market, cost of production is overstated and in a falling market the cost of production is understated.
Impact of LIFO Method on Inventory Valuation
The value of closing stock does not reflect the current market price as all the rates of latest purchased materials are used for issue purpose. Thus. closing stock is valued at old rates but not at the current rates of materials.
Impact of LIFO Method on Profit
1. The total profit will not get affected under this method because a rise in price may be compensated by a fall in prices over a period of time. However, profits of every product or job differs because of charging of different rates of materials to different products.
2. In period of rising prices, the higher rates of materials are charged to production, thereby inflating the cost of production. This results in a reduced margin of profit resulting in tax deduction.
- Meaning of Cost Accounting | Nature and Scope of Cost Accounting
- Cost Accounting | Purpose or Functions of Cost Accounting
- Advantages and Disadvantages of Cost Accounting
- Difference between Cost Accounting and Management Accounting
- What is Cost Concepts and Different Terms of Costs
- What is concept of Cost Audit | Objective and Scope of Cost Audit
- Advantages and Disadvantages of Cost Audit
- Meaning of Methods of Cost | Basic Methods of Costing
- What is meaning of Classification of Cost & elements of Cost | rules of Cost Accounting Standard
- What is Installation of a Costing System | Conditions and Factors
- What are the practical difficulties in installing cost accounting
- What is technique of Costing | Various techniques of Costing
- What is Material or Inventory Control | Techniques of Materials Control
- What is FIFO Method | advantages and disadvantages
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