Explain the difference between the FIFO method of inventory valuation and the LIFO method. Which of these methods best approximates the physical flow of units for most$$ companies? Explain.

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Part $1$

Explain the difference between the FIFO method of inventory valuation and the LIFO method.

A$.$

The$$ first$-$in$,$ first$-$out$($FIFO$)$ method assigns the most recent costs to ending inventory and the oldest costs to cost of goods sold. FIFO cost flows will better match the unit flows of most entities.$$ Conversely, the$$ last$-$in$,$ first$-$out$($LIFO$)$ method assigns the oldest costs to ending inventory and the most recent costs to cost of goods sold.

B$.$

The$$ last$-$in$,$ first$-$out$($LIFO$)$ method assigns the most recent costs to ending inventory and the oldest costs to cost of goods sold. LIFO cost flows will better match the unit flows of most entities.$$ Conversely, the$$ first$-$in$,$ first$-$out$($FIFO$)$ method assigns the oldest costs to ending inventory and the most recent costs to cost of goods sold.

C$.$

Under$$ first$-$in$,$ first$-$out$($FIFO$),$ the company identifies each unit and tracks the cost associated with that specific unit. Under the$$ last$-$in$,$ first$-$out$($LIFO$),$ the company determines an average cost for the units on hand and applies that average unit cost to the next sale to determine the cost of goods sold.

D$.$

Under$$ last$-$in$,$ first$-$out$($LIFO$),$ a company determines the inventory balance and cost of goods sold at the end of the accounting period. Conversely under the$$ first$-$in$,$ first$-$out$($FIFO$),$ a firm continually updates inventory accounts for each purchase by recording the cost of goods sold after each sale.

Part $2$

Which of these methods best approximates the physical flow of units for most$$ companies? Explain.

$$

$$

FIFO

LIFO

could be a more accurate representation of the actual flow of goods for any entity that accumulates$$ inventory, sells units from its

$$

$$

most recent

oldest

acquisitions and maintains a base stock$($e$.$g$.$ mining$).$ However,

$$

$$

FIFO

LIFO

$\text{'}$s

cost flows will run counter to the way most firms manage their inventory unit flows due to issues such as inventory obsolescence.