Sign up  |  Log in

LIFO Liquidation

Hello all.

There is one question that is killing me to know.
Under LIFO Liquidation we will of course adjust the COGS by adding the Liquidation amount to get a realistic picture of the cost of sale for the company. Now my question is:
If for the same company we would use FIFO wouldn`t this make the COGS even more unreliable since basically it would be even lower than COGS with LIFO liquidation? If that`s the case how come is FIFO considered better even though it assumes cost flow? No matter what method you use to me it seems that unless you can calculate specific cost for each unit all the others are just “bad” in the sense that no one is superior to the other.
Please help me with the logic of this. I know how to calculate everything but it just does not make sense in my mind.

Thanks.

Kick start your CFA® Program prep with Top Instructors you’ll love and a course that offers free updates until you pass – We’ve got you covered.

In general, unless you don’t use the specific cost accounting method (which is only applicable for very specific goods) there is no “correct” inventory accounting method. Assuming rising prices, LIFO will give you the best approximation for the COGS (income statement=IS), however the worst approximation for the Inventory (balance sheet=BS). In contrast to this, FIFO will give you the best approximation on Inventory, and the worst on COGS. Using the weighted average cost method will result in values between LIFO and FIFO without a special focus on BS or IS. The question here ist not what is superior to the other, but whether you want to have a more realistic picture on the BS values or on the IS values.
If you assume falling prices then the above is still true, but in the reverse manner.
Hope this helps!

Regards,
Oscar

Thank a lot for the reply Oscar :) Your logic really makes sense.

I got confused because i got the idea that FIFO was better than LIFO liquidation when it clearly isn’t in case of rising prices. The book makes FIFO the default “more correct” choice when it clearly depends on what you want do analyse at the moment.

Bests,

Kris