Choosing the right inventory valuation method significantly impacts your business finances, tax obligations, and decision-making. For Pakistani businesses, understanding FIFO (First In, First Out) and LIFO (Last In, First Out) is essential for proper accounting and FBR compliance.
What is Inventory Valuation?
Inventory valuation determines the cost assigned to goods sold and remaining inventory. Since purchase prices fluctuate, the method you choose affects your Cost of Goods Sold (COGS), profit margins, and tax liability.
Understanding FIFO (First In, First Out)
FIFO assumes that the oldest inventory items are sold first. The cost of goods sold reflects earlier purchase prices, while ending inventory reflects recent costs.
FIFO Example in PKR
A Lahore electronics shop purchases mobile phone chargers:
- January: 100 units @ PKR 200 each = PKR 20,000
- February: 100 units @ PKR 250 each = PKR 25,000
- March: Sold 120 units
Under FIFO:
- COGS = (100 × PKR 200) + (20 × PKR 250) = PKR 25,000
- Ending inventory = 80 units × PKR 250 = PKR 20,000
Advantages of FIFO
- Matches physical flow – Most businesses naturally sell older stock first
- Higher ending inventory value during inflation
- Better balance sheet representation
- Widely accepted by international accounting standards (IFRS)
- Preferred by FBR for tax purposes in Pakistan
Understanding LIFO (Last In, First Out)
LIFO assumes that the most recently purchased items are sold first. This method results in higher COGS during inflation, reducing taxable income.
LIFO Example in PKR
Using the same electronics shop example:
Under LIFO:
- COGS = (100 × PKR 250) + (20 × PKR 200) = PKR 29,000
- Ending inventory = 80 units × PKR 200 = PKR 16,000
Advantages of LIFO
- Tax benefits during inflation (higher COGS = lower taxable income)
- Better matching of current costs with current revenues
- Cash flow advantage through reduced tax payments
FIFO vs LIFO: Side-by-Side Comparison
| Factor | FIFO | LIFO |
|---|---|---|
| Cost of Goods Sold | Lower (older prices) | Higher (recent prices) |
| Ending Inventory | Higher value | Lower value |
| Net Profit (inflation) | Higher | Lower |
| Tax Liability | Higher taxes | Lower taxes |
| FBR Acceptance | Preferred | Limited acceptance |
| IFRS Compliance | Yes | Not allowed |
| Physical Flow Match | Usually matches | Rarely matches |
Which Method Should Pakistani Businesses Use?
FIFO is Recommended When:
- Selling perishable goods (food, medicine, cosmetics)
- Dealing with products that have expiry dates
- Need IFRS compliance for international reporting
- Want accurate balance sheet valuation
- Operating pharmacies or FMCG distribution
Consider Weighted Average Instead of LIFO
Since LIFO is not permitted under IFRS (which Pakistan follows), most Pakistani businesses use either FIFO or Weighted Average Cost method.
Weighted Average calculates a single average cost for all inventory:
- Total Cost = PKR 20,000 + PKR 25,000 = PKR 45,000
- Total Units = 200
- Average Cost = PKR 225 per unit
- COGS (120 units) = PKR 27,000
Impact on Your Business Decisions
Pricing Strategies
FIFO helps maintain consistent profit margins by reflecting current market costs in your ending inventory valuation.
Tax Planning
Understanding inventory valuation helps with FBR tax compliance and year-end accounting preparation.
Inventory Management
Proper valuation integrates with your overall inventory management strategy and helps identify dead stock.
Implementing FIFO in Your Business
Manual Tracking Challenges
Tracking FIFO manually or in Excel spreadsheets becomes complex as your inventory grows. Common issues include:
- Multiple purchase batches at different prices
- Partial sales from multiple batches
- Returns and adjustments
- Multi-location inventory
Automated Solutions
Modern accounting software automatically tracks inventory using FIFO or Weighted Average methods, ensuring accurate costing without manual calculations.
HysabOne automatically applies FIFO valuation to your inventory, calculating accurate COGS and maintaining proper inventory reports for Pakistani businesses.
Frequently Asked Questions
Is LIFO allowed in Pakistan?
Which method gives lower taxes?
Can I switch inventory valuation methods?
How does FIFO affect my profit margins?
What is the best method for retail businesses?
Conclusion
For Pakistani businesses, FIFO is the recommended inventory valuation method due to IFRS compliance requirements and FBR acceptance. It accurately reflects inventory value, matches physical goods flow, and simplifies tax reporting.
Ready to automate your inventory valuation? Try HysabOne – Pakistan’s smart accounting software with automatic FIFO tracking, real-time inventory reports, and seamless GST compliance.