The inanity of it all.
A hotly debated topic in accounting is the valuation of inventory for the current asset section of the balance sheet, and for the cost of goods sold expense line of the income statement. The methods that surface during any discussion are:
- Specific identification–permanently remember how much was paid for an item. When that item is sold, move the asset value from the inventory account to the cost of goods sold account. This method is theoretically superior in a context of historical cost accounting and matching cost to revenue. This method is impractical because there are far too many items being purchased and sold to bother with all the identification and record keeping. Hence, there are methods for approximating values.
- FIFO–first-in/first-out. Since the physical flow of inventory items is usually for the oldest items to be sold before newer items, the oldest inventory costs are the first to be moved from the inventory account to the cost of goods sold account. It is easy to implement, because the cost of goods sold computation is Beginning Inventory + Purchases − Ending Inventory. The amount of purchases is easily determined by summing all debits to the inventory account, and ending inventory can be computed by reference to the latest invoices.
- LIFO–last-in/first-out. Historically, there has been time lag between purchase and sale of inventory items, so there is opportunity for post acquisition market fluctuations. LIFO does a fine job of matching current cost with sales revenue, thereby emphasizing the income statement. Analysts like this.
Ed Scribner, of New Mexico State University, substitutes the acronym FISH in place of LIFO. He reasons that if the last in costs are first sent to cost of goods sold, then the first in items are still here: FISH (first-in/still-here). He also substitutes LISH (Last-In/Still-Here) for FIFO. Any accountant that says LISH must be a lush.
LIFO was initially put forth as a way of minimizing taxes after the imposition of the first federal income tax. The baseline rate of 1% met with much complaint on the part of American citizens. U.S. law insists that use of the tax deduction be mirrored in financial reporting. Except for that, there is no hue and cry on the part of U.S. corporations for its continued use in financial reporting. The law could be changed (and I have heard that a change is reasonably possible) to permit continued use of the tax deduction but no longer require its mirrored use in financial statements if IFRS are adopted by the SEC.
Many internationals consider U.S. use of LIFO for financial reporting purposes to be ridiculous and absurd. Their dislike is of it seems to be so strongly held that it approaches religious fervor. Presumably it is because it is crass cost manipulation. In actual practice, all companies and products physically flow in a FIFO manner. Internationals argue, with considerable sound reason, that cost flow should match the physical process.
Personally, I think that perpetual LIFO is the single most ridiculous part of financial reporting.
It is also reasonably possible that LIFO could be discontinued for tax purposes. If it is discontinued, it will be because some governmental officials have decided not to offer that particular deduction any more. Given that Prez Obama is about to ring up a nearly 2 trillion deficit and is about to hike taxes up to the nanosphere, perhaps he will move for LIFO elimination. The timing has never been better to discontinue LIFO in the United States.
There are other methods of accounting for inventory. When accounting professors get together at cocktail parties these other methods are always discussed. There is NIFO, LieFO, and the FIFO/LIFO combo. My apologies to Edwards and Bell.
Debit and credit – – David Albrecht