Premises, cash and stock are fundamental to retail businesses. How a business accounts for stock can have a significant effect on net income and book value and, in turn, on taxation. There are various accounting techniques in managing stock, below are the two main types of techniques:-
– FIFO stands for “first-in, first-out” – with FIFO the oldest stock items are stated as sold first. However this does not exactly mean that the actual oldest physical object has been tracked and sold; this is just an accounting technique.
– LIFO stands for “last-in, first-out” – this translates into the most recently produced items are recorded as sold first. In the USA, most companies use LIFO because it reduces their taxes in times of inflation. LIFO is only used in Japan and the USA.
The difference between the cost of a stock calculated under the FIFO and LIFO methods is called the LIFO reserve. This reserve is essentially the amount by which the tax has been deferred by when using the LIFO method.
Due to LIFO’s potential to skew inventory value, UK GAAP and IAS have effectively banned LIFO stock/inventory accounting.
Many companies will also state that they use the “lower of cost or market.” This means that if stock/inventory values were to plummet, their valuations would represent the market value (or replacement cost) instead of FIFO, LIFO or average cost.
Understanding stock calculation might seem overwhelming, but it is something you need to be aware of and if you do not, you should ask your retail accountant or retail auditor.