Industry, regulatory and tax considerations
Accountants use “inventoriable costs” to define all expenses required to obtain inventory and prepare the items for sale. For retailers and wholesalers, the largest inventoriable cost is the purchase cost.
On the other hand, manufacturers create products and must account for the material, labor, and overhead costs incurred to produce the units and store them in inventory for resale.
You should also know that Generally Accepted Accounting Principles (GAAP) allow businesses to use FIFO or LIFO methods. However, International Financial Reporting Standards (IFRS) permits firms to use FIFO, but not LIFO. Check with your CPA to determine which regulations apply to your business.
Lastly, the inventory method you choose may impact your income tax liability. To explain, assume that Sterling sells 300 shirts on December 31st, 2021.
The FIFO and LIFO compute the different cost of goods sold balances, and the amount of profit will be different on December 31st, 2021. As a result, the 2021 profit on shirt sales will be different, along with the income tax liability. Again, these are short-term differences that are eliminated when all of the shirts are sold.
FIFO is the easiest method to use, regardless of industry, and this inventory valuation method complies with GAAP and IFRS. Use the FIFO method for your inventory transactions.
Accounting for inventory is essential—and proper inventory management helps you increase profits, leverage technology to work more productively, and to reduce the risk of error.
