Finance: What is LIFO v FIFO?

What is LIFO v FIFO? LIFO and FIFO are acronyms for Last In, First Out and First In, First Out. The terms are applicable to several different types of businesses. Inventory management refers to items that arrive from a factory or distributor and the speed at which they are sold. In some industries, such as in film and tv, prints and advertising finance is often LIFO, as their involvement in the distribution cycle is only required for theatrical release. They are often the last post production budget entry, yet they are paid off first to minimize unnecessary carried interest charges.

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Transcript

00:20

wants inventory to be counted based on the most recent

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prices in the market place that's life O as in

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last in First out So there is a war It's

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not in the White House It's not China It's not

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in the Middle East It's in the hallowed halls of

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accounting firms everywhere Life Oh refers to inventory cost accounting

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such that it counts the cost of the most recent

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inventory acquired as the expense against revenues rather than the

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first inventory acquired on what does all that mean All

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right well let's look at Silly Putty a product vital

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to the American psyche and built largely from highly volatile

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Lee priced petroleum products All right Luckily for the sellers

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of the Putty it last male almost forever And so

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life O V Fi Foh becomes a big deal for

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the putty they bought three years ago In the massive

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shelf stocking exercise of two thousand sixteen The sellers of

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party were paying two dollars an egg all in for

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that product inventory But then three years later in our

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current era after the great Somalian warlord rebellion had petroleum

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costs skyrocketing such that the cost of the putty inside

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that egg went from two bucks Tow three box and

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they're still selling the putty thing there for five bucks

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each right So life Oh style accounting would claim that

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the expenses mapped against the five dollars per egg revenues

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would be the last in egg prices Or that three

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dollars and egg inventory unit cost showing a gross profit

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of two dollars Had the company been using Ah fife

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Oh style of accounting Well then they would have looked

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to the three year old cost of a two dollar

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an egg inventory cost and they would be showing a

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three dollars per egg gross profit Yet another player in

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the accounting Octagon That's what that looks like is what's

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called the average cost of inventory calculation Where in well

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here that average cost might be answer to fifty and

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egg which would then give Ah fifty percent gross margin

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or profit per egg sail on a five dollars selling

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price of two Fifty Well why does all this matter

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Well a few things heir issue here showing higher expenses

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on the inventory shows lower accounting profit to the company

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and it is on that operating profit that the company

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is then taxed So if the company is able to

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show less profits well then it simply pays less in

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taxes But if the company is publicly traded well then

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shareholders of the company I either owners likely get punished

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in the public markets in the form of a lower

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stock price at least for a while Because instead of

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trading at twenty times earnings of three dollars twelve cents

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a share or sixty two dollars in change the company

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using the higher inventory cost now to show lower profits

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well on Lee shows profits or earnings of two eighty

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a share Still likely trading at that twenty times earnings

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number for a fifty six ish dollars a share trading

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price or roughly nine ish percent discount to where they

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were trading Otherwise it's not quite that simple but that's

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the idea In theory there are other adjustments that need

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to get made on the company's balance sheet Then as

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Well that is if the value of their inventory has

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gone up some fifty percent and that inventory comprises a

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meaningful amount of asset value to the company like you

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know in the But he's going off from two to

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three bucks Well then the decision is whether that inventory

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should be held at market value I eat the new

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higher price three dollars an egg putty or at the

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acquisition cost i e The historical Three years ago two

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dollars per egg putty For the old units that were

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acquired a more middle of the road number would be

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just that average cost thing at two fifty or average

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adjusted book value Cost these numbers in a vacuum don't

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mean a whole lot But in a highly volatile industry

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like this one or rather industries with highly volatile expense

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input the FIFA Life Oh smackdown can have huge changes

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in reported company profits depending on which gets applied Think

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airlines where fuel costs can run anywhere from twenty thirty

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forty fifty send in the cost of running the airline

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and in areas where fuel prices can double or triple

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in a heartbeat and or get cut in half in

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a year or less Well you can imagine that the

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reported earnings numbers would be a harder to wrestle down

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then Well this guy