Inventory valuation is an accounting process used by companies to assign value to their inventory. It determines the cost of unsold goods at the close of an accounting period and plays a critical role in calculating the cost of goods sold (COGS) and the gross profit for the period.
The main reason for this process is to assign a monetary value for a company’s inventory items at the close of a reporting period. There are several methods used for inventory valuation. Each method affects the financial statements differently, especially under varying market conditions.
Advantages of LIFO
The LIFO (Last-In, First-Out) accounting method assumes that the inventory items most recently purchased are the first ones sold or used, which means that the COGS is calculated using the most recent inventory costs, leaving older inventory costs in the ending inventory balance.
Tax Savings & Cash Flow Improvement
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- LIFO can lead to lower cost of goods sold (COGS) during inflation.
- LIFO can result in lower taxable income in times of inflation because it matches higher current prices with current sales, thereby reducing reported profits and tax liabilities.
- Cash flow can be improved by deferring taxes since LIFO reports lower profits in times of rising prices.
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