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fifo & lifo effect on financial ratio
In manufacturing business unit many of organization use FIFO due to wastage of material. On the other hand Financial Ratio is very important to availability of cash to pay debt. It measures how fast we can convert non cash assets to cash assets. It's call Debt Ratio too.
FIFO assumes asset values are higher on the balance sheet, which improves all three measures ( liquidity, net worth and asset turnover) used in balance sheet analysis.
Last in first out(LIFO) and First in First out(FIFO) are two methods of costing of inventories. As per IFRSs LIFO is not reliable method, Weighted average and FIFO are allowed in IFRSs. FIFO assumes that the inventories produced/procured first are consumed/sold first, thereby, making the presentation of cost of goods sold more realistic than LIFO in the financial statements.
An Entity should use FIFO method for inventory unless otherwise it is a fresh food industry
in the period of rising prices, FIFO gives you a lower cost of good sold and higher ending inventory value thus a higher net income
In case of inflation and the company uses fifo in its evaluation it will lead to :
1. The cost of good sold will decrease
2. Ending inventory will increase
3. inventory turnover ratio will decrease
4. Day’s sales in inventory will increase
5. Operating cycle and cash cycle will increase which have its bad effect on liquidity
6. Current ratio will increase because inventory increased
7. Gross profit will increase
8. Net profit and net profit percentage will increase
The vice versa if the company uses lifo under inflation.
So according to economic condition and the company condition the company choose its inventory recording method and the company should set each scenario in consideration before it decide to use any one of them
first IFRS prohibited LIFO and what is used is FIFO and average coast
It also provides guidance on the cost formulas that are used to assign costs to inventories. Inventories are measured at the lower of cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
The cost of inventories includes all costs of purchase, costs of conversion (direct labour and production overhead) and other costs incurred in bringing the inventories to their present location and condition. The cost of inventories is assigned by:
