Managing your merchandise effectively can mean the difference between a loss or a profitable year. There are certain methods of accounting for inventory set by the Internal Revenue Service that impact how your taxes are filed. Inventory includes a variety of items, such as raw materials and finished products.
FIFO and LIFO methods
Values of items in inventory are not always the same. If you can’t identify which item matches up to which particular invoice or cannot determine the cost of an item, then there are accounting methods to help you identify values. Here are two commonly used methods:
- First-in first-Out (FIFO) – Under the FIFO method, the items first sold or used are assumed to be the first items purchased as inventory. At the end of the year, costs are assigned to the remaining inventory of what you produced or purchased at the most recently incurred price. FIFO is a pretty logical approach and most businesses operate this way.
- Last-in first-out (LIFO) – A method that lies at the opposite end of the spectrum. LIFO assumes that the most recent items in the inventory are the first to go. It can be often used to adjust profits, such as during product price inflation, which may lead to a company lowering its applicable tax bracket.
Often because it requires specific permission from the IRS with IRS Form 970, LIFO is not as common. It is also not accepted in international financial accounting standards. So, most companies prefer to use FIFO.
Managing how your business records inventory can be a daunting task. Having a skilled accounting squad at your side presenting solution for the needs of your business is the best way to go. MiklosCPA, a California-based firm, has helped many businesses with their accounting and taxation needs through our “virtual office” services. Give us a call if you want to learn more about our services! Also check back for future tax tip articles like this one here on our website and on our social media pages.