ANALYZING THE EFFICIENCY AND EFFECTIVENESS OF FIFO METHOD ON

RISING PRICES: A COMPREHENSIVE ASSESSMENT

A Research Paper Presented to the

Faculty of Business Administration Division

La Conception College, Inc.

In Partial Fulfillment of the Requirements for the Degree

Bachelor of Science in Accountancy

by

Rhei Jome S. Dela Merced

Mark C. Duran

Jason Patrick J. Natad

Charles Rendelle Quiroz

May 2024
 CHAPTER 1

THE PROBLEM AND ITS BACKGROUND

Introduction

There are retailer and merchandising businesses operate in the area of San Jose Del
Monte Bulacan which purchase their inventory as their valuable assets to subsequently be
sold. It terms of Inflation; it is needed what cost needs to be assigned to their inventory.
In Instance, if Khayil clothing store purchase merchandises four times in a month at P50,
P60, P70, P80, what cost must be attributed to inventory at the end of month?
Furthermore, in terms of obsolescence of inventory, Retailer and Merchandising
Businesses in San Jose Del Monte may experience lack of demand of product which
causes of becoming obsolete of the product to be sold after a certain amount of time
passes and reaching the ends of its lifecycle that leads to unsellable product as what (Ian
McCue says in ORACLE NetSuite, October 15, 2020). Businesses in San Jose del Monte
Bulacan such as drugstores, grocery stores, and supermarkets sell medicines and food
products and they can sell Goods or products already expired due to improperly
managing their inventories to be sold which can result loss of its value and the reduction
of their buying customer. The question is what method will be used in their inventories
applicable to their business?
FIFO is the most popular in the Three method of Inventory Valuation for a good
estimate of closing stock. In fact, FIFO is one of the most widely used inventory
accounting method because Inventory Management is crucial for businesses that deals
with physical products. To meet customer demand, minimize costs, and maximum profit,
the effective Inventory Management is necessary. (JHGROUP May 3, 2023)
FIFO is an accurate and easy in a way of calculating ending inventory value by
using FIFO and using FIFO, the business can properly manage the inventory to share
money and benefit of your customer. The importance of using FIFO is when inflation
increases because the most recent inventory would likely cost more than older inventory
(Jef White, Rob watts May 12,2023)
FIFO is a crucial tool for businesses of all sizes as it helps to ensure that the right
products are shipped to customers, components are used correctly, and costs remain under
control. In addition, by implementing a FIFO system, businesses can better manage their
inventory and increase efficiency across the board. This will lead to higher customer
satisfaction rates and ultimately increased profits. (Mark Buzinkay)
However, Following FIFO method increases tax liability because of FIFO, the
profit is increased. Thus, other businesses use LIFO for the purpose of saving taxes.
Under this method the liability is lower because of the profit margin is lower.(Tanoy,
zoho.com, 2019) but this method is not allowed for tax purposes(tax summaries’,
February 22, 2024) and for international trade because it does not meet the requirement of
IFRS that requires the company to value their inventory using a consisted method over
time.(November 25, 2020, Quora)
The importance of this study is how businesses or business companies in San Jose
Del Monte Bulacan do manage their inventories when they operate as the retailer and
merchandiser. Furthermore, how they provide their customers with its commodities, and
satisfied prices. Moreover, what method must be used for their businesses that allowed by
IRS and lastly, how businesses to value their ending inventory at the finish of an
accounting period that this amount can help businesses determine their Cost of Goods
Sold, an important number for budgets and evaluating profitability.

Hypothesis

Ho

 During periods of rising prices, the FIFO inventory costing method will lead to
higher reported profits compared to alternative methods like LIFO or WAC.
Ha

 While the FIFO inventory costing method might improve short-term profitability
during rising prices, it can lead to inefficiencies in inventory management and
potentially inaccurate financial statement valuations.

Theoretical Framework

1. Inventory Management Theories:

 Just-in-Time (JIT) Inventory: Analyzes how FIFO aligns with JIT

principles during inflation. Considers trade-offs between minimizing

inventory holding costs and potential stockouts due to rising prices.

 Economic Order Quantity (EOQ): Explores how FIFO affects the

calculation of EOQ, the optimal order quantity for inventory items.

Rising prices in FIFO might influence reorder points.

2. Accounting Theories:

 Matching Principle: Evaluates how FIFO aligns with the matching

principle, which states that expenses should be recognized in the same

period as the revenue they generate. During inflation, FIFO might lead to

a better cost-revenue match.

 Going Concern Principle: Examines how FIFO affects the going concern

assumption, which states a company intends to operate in the foreseeable

future. An undervalued inventory in FIFO might raise concerns about a

company's ability to continue operations.

 3. Financial Analysis Theories:

 Financial Ratio Analysis: Analyzes how FIFO impacts key financial

ratios like inventory turnover, current ratio, and return on equity. Rising

prices in FIFO might affect these ratios differently compared to other

inventory costing methods.

 Profitability Analysis: Explores how FIFO influences reported profits

and potential implications for shareholder value and investment

decisions.

Statement of the Problem

1. What are the demographic profile of the respondents in terms of:

1.1 Name

1.2 Type of Business

1.3 Position

1.4 Number of Years of Occupation

2. How does efficiency and effectiveness of FIFO method be describe in terms of;

2.1 Operational Challenges

2.1.1 Inventory Management

2.1.2 Financial Implications

2.2 Operational Benefits

 2.2.1 Cost Management

2.2.2 Process Efficiency

3. How does the FIFO method influence inventory in increasing prices in terms of:

3.1 Inventory Valuation

3.2 Profitability

3.3 Tax Implications

3.4 Price Management

4. Does the utilization of the FIFO method significantly impact inventory valuation

and cost management strategies amidst rising prices?

5. What are the practical implications and recommendations for businesses aiming

to optimize inventory management practices amidst escalating prices using FIFO?

Objectives of the Study

The objective of the study is to evaluate the effectiveness and efficiency of the

FIFO method in managing the inventory cost during rising prices.

Specifically, this study aims to:

1. To determine the demographic profile of the respondents in terms of name,

and type of business.

2. To identify the efficiency and effectiveness of FIFO method.

 3. To assess how does the FIFO method influence inventory in increasing prices

4. To determine the significant impact of FIFO method in inventory valuation

and cost management strategies amidst rising prices

5. To identify the practical implications and recommendations for business

aiming to optimize inventory management practices amidst escalating prices using

FIFO.

Significance of the Study

The result of the study will benefit the following:

1. Businesses and Corporations: Companies that utilize the FIFO (First-In-First

Out) inventory management method can benefit significantly from this research.

Understanding the efficiency and effectiveness of FIFO in the context of rising

prices can help businesses optimize their inventory management strategies, reduce

costs, improve profitability, and make informed decisions regarding pricing and

supply chain management.

2. Investors and Shareholders: Investors and shareholders of companies that

implement the FIFO method can benefit from this research by gaining insights

into how FIFO impacts the financial performance and profitability of these

companies. This information can help investors make more informed investment

decisions and assess the potential risks and returns associated with investing in

FIFO-using businesses.
 3. Academia and Researchers: Academics and researchers in the fields of

accounting, finance, economics, and supply chain management can benefit from

this research by gaining a deeper understanding of the implications of using the

FIFO method in inventory valuation during periods of rising prices. The findings

of this research can contribute to existing literature, stimulate further research, and

enhance knowledge in these disciplines.

4. Regulatory Bodies and Policy Makers: Regulatory bodies and policy makers

involved in setting accounting standards, financial reporting requirements, and

inventory valuation guidelines may also benefit from this research. The insights

provided by this study can inform regulatory decisions related to inventory

valuation methods, financial reporting practices, and compliance with accounting

standards.

5. Consumers: While indirectly impacted, consumers may also benefit from this

research as a better understanding of how FIFO affects pricing strategies could

potentially lead to more transparent pricing practices by businesses, which could

ultimately benefit consumers through fairer pricing mechanisms.

Scope and Limitation of the Study

The scope of this study is limited to evaluating the effectiveness of the First-In,

First-Out (FIFO) inventory management method specifically in the context of increasing

prices. The research will be conducted solely in Brgy. Kaypiam, San Jose, Bulacan. The

study aims to analyze how well the FIFO method performs when prices are on the rise

and whether it assists businesses in maintaining profitability and competitiveness during

such economic conditions. The research will focus on understanding the impact of FIFO

on inventory turnover, cost of goods sold, and overall financial performance within the

specified location and economic scenario.

Definition of Terms

Cost of Goods sold - the cost of Goods which have been sold.

Inflation - increasing price of Goods and service.

Inventory management - is responsible for ordering and tracking inventory stock

when the stocks arrive at warehouse.

Inventory obsolescence - the dead or excess stock due to lack of demand.

Inventory valuation - an accounting process used to recognize the value of

unsold product or inventory at the time preparing financial statement.

Manufacturing Businesses - Those Businesses produce product by using raw

materials.

Merchandising Businesses - They are buying and selling product.

Tax Liability - is the amount of tax debt owed by business entities to government.
 CHAPTER 2

REVIEW OF RELATED LITERATURE

Foreign Literature

The study by Anita C Sembiring et al (2019), focuses on improving the inventory

system of a company, particularly in managing raw materials and reducing expired

products.

The study provides valuable insights into how improving inventory systems can

lead to better decision-making processes and ultimately reduce waste and losses due to

expired products. By analyzing the efficiency and effectiveness of the FIFO method, the

researchers can further explore how implementing such inventory management strategies

can positively impact cost control, profitability, and overall operational performance

within a company.

In summary, by understanding and incorporating the findings from the study by

Anita C Sembiring et al. on inventory system improvement and connecting it to your

assessment of the FIFO method in rising prices reporting, you can enhance your research

by emphasizing the practical implications and benefits of adopting efficient inventory

control methods in today’s business environment.

 According to Hand (2024) Over time, inflation typically drives up the cost of

inventory when adopting the FIFO technique. This implies that items acquired sooner are

typically less expensive than those acquired later. The higher-valued items make up the

majority of your closing inventory as FIFO presumes that the lower-valued commodities

are sold first. The finishing inventory value is higher as a result. Using FIFO can

significantly boost a company's financial results since a greater inventory valuation can

enhance a brand's balance sheets and reduce inventory write-offs.

Moreover, according to Uzialko (2024), Due to economic fluctuations and the risk

that the cost of producing goods will rise over time, businesses using FIFO are considered

more profitable – at least on paper. Companies that sell perishable products or units

subject to obsolescence, such as food products or designer fashions, commonly follow the

FIFO inventory valuation method. It serves as an optimal valuation method for businesses

aiming to impress investors, though it presents a challenge in terms of increased tax

liability. This is because FIFO leads to a lower recorded cost per unit, consequently

reflecting higher pretax earnings. As a result of these higher profits, companies inevitably

encounter elevated tax obligations.

Furthermore, according to White et al., (2023) Inventory is typically considered an

asset, so your business will be responsible for calculating the cost of goods sold at the end

of every month. With FIFO, when you calculate the ending inventory value, you’re

accounting for the natural flow of inventory throughout your supply chain. This is

especially important when inflation is increasing because the most recent inventory would

likely cost more than the older inventory.

Foreign Studies

According to Tardi (2023), in a rising price market, FIFO leaves the more

expensive, fresher inventory on the balance sheet. Because inventory that may be several

years old and that was purchased at a reduced cost is used to evaluate COGS, FIFO can

thereby improve net profitability.

Also, according to Husain (2020), FIFO is considered a more logical and reliable

method. With this method, the risk of decreasing the quality of goods due to being stored

for too long can be minimized. Apart from that, here are some other advantages of the

FIFO method. An inventory information system employing the FIFO method tracks the

movement of goods both into and out of inventory. FIFO, which stands for First In, First

Out, is a sales approach that prioritizes selling the oldest received goods first to maintain

product quality and prevent expiration. These FIFO-based inventory systems have been

extensively utilized or developed across companies, leveraging diverse technologies and

systems. (Roziqin et al., 2021)

Moreover, according to (Srbinovska et al, 2020) Inventory valuation is a major

topic in the accounting practice. Inventory valuation is reflected in financial reporting, i.e.

the balance sheet and the profit and loss account and the choice of the right inventory cost

flow method is one of the basic decisions all companies engaged in manufacturing and

distribution of goods need to make. The choice of inventory valuation method is

primarily influenced by the manager’s educational background, comprehension of the

process, and ease of use of the various methods

Furthermore, the study examined the implication of the choice of inventory

valuation methods on profit, tax and closing inventory. Calculations were made to find

out the impact of the FIFO and Weighted Average methods of inventory valuation on

profit, tax and closing inventory. From the study, it was discovered that the choice of

inventory valuation methods Impact directly on the profit, tax and closing inventory of

any company and also confirmed the existence of a very strong significant correlation

between the choice of inventory valuation method and profit, tax and closing inventory.

Consequently, the researchers concluded that choice of inventory method has much

impact on the dependent variables of the study hence the need for companies to critically

examine the methods of inventory valuation before making choice. (Simeon et al., 2018)

Local Literature

According to Sanico et al (2023) it is crucial that businesses regularly assess their

operations. One of the key components of any firm is inventory management. They have

to make sure that they monitor their inventory and determine whether they have the

appropriate number of things on hand for when their consumers need them. It's crucial

that they understand whether their excessive product inventory is costing them money.

Some companies do not know what right inventory costing method will be used

for their business. In this case, it depends on what kind of goods or products to be sold to
customers. When the goods of business company are perishable, FIFO method is better to

avoid the risk of losing product that can become unmarketable due to the obsolete

inventory of products. By FIFO method, it can help to minimize losing products since the

goods that were purchased is the good that sells out first.

Furthermore, FIFO is the more transparent method compared to other method. The

nature of FIFO method is following more natural inventory flow and because of its

nature, FIFO methods simplifies the record-keeping process and the probability of

mistake in the bookkeeping can be lower. In fact, the FIFO is the most popular method

for many businesses as it is permitted by the International Financial Reporting Standard

(IFRS), and the General Accepted Accounting Principles (GAAP)

In terms of fluctuation, FIFO is more favored when the product market price rise

dramatically. During inflation, because of your cheaper and older goods are being

recorded by using the FIFO that gives you a lower cost of goods amount by Rivera

(2020).

Moreover, inventory footnote can provide insights on cashflow as making the

financial statements. Making an inventory footnote of inventory valuation method is

crucial and the best valuation method known is FIFO in which a higher gross profit,

higher ending inventory, higher taxable income, and lower Cost of Goods Sold (COGS)

are provided by this method as lower gross profit, lower ending inventory, lower taxable

income, and higher Cost of Goods Sold (COGS) are the reverse effect provided, however,

by using the FIFO method by Dela Cruz (2022)

 According to Shopify Staff (2022) the system of FIFO, it helps determine the cost

of goods sold and remaining inventory value by recording the oldest inventory items as

sold before new one.

Moreover, the system determines profitability through the use of the associated

cost of that oldest merchandise also sold first.

However, there are merchandisers do not follow the assumption of FIFO and they

sell mixed goods of new and older merchandise in reality. But FIFO has to do with

calculation the cost of that merchandise with applying the older cost before new one. This

can result of profits to be higher with FIFO method.

The practice of FIFO is commonly applied in the industry of restaurant. The staff

of restaurant ensures using first the ingredients with earlier expiration date in the

preparation on the order of food whenever they receive first produce. It can help in

reducing the wastage of ingredients or produces.

Moreover, it can help to implement this method to kitchen in reservation. If this

method is being applied to reservation, the oldest reservations can be priorities by the

restaurant before new one. Applying FIFO method aligns with chronological principle

and also helps in managing customer expectations. (MOSAIC, 2023)

Local Studies
 According to Ching et al. (2019), and the Department of Industrial Engineering,

De La Salle University (2019), Perishable inventory management serves dual purposes

for both society and the economy: it minimizes food wastage while maximizing the value

of fresh goods. Consequently, numerous mathematical models have been devised to

enhance efficiency and cost-effectiveness. However, most of these models can only

optimize systems within a restricted time frame, resulting in incremental improvements in

operations management without addressing the underlying patterns in inventory levels.

Based on the study intended for evaluating the FIFO inventory management

practices used by 2 fast food chains in Manila, these are the Jollibee and McDonald’s in

order determining its effect on the operational efficiency of their businesses through their

inventory control (Technological Institute of the Philippines,2023) there is significant

effect by using the FIFO on their operational efficiency based on their inventory control

which can be measured by their warehousing inventory, quality and quantity control and

financial planning and monitoring.

Thus, by means of this study, it proves that using the FIFO method as their

inventory management practices is effective that enhances efficiency in operation.

Moreover, FIFO method is helpful when there are multiple items of the same

product. Additionally, it maintains freshness and quality by means of adhering to specific

storage times of common food item.

Using a FIFO food storage system is simple and efficient. Using or buying the

older products before newer is insured in which it helps to minimize costly wastage
(Adlawan, 2021) as many businesses company specially in food industries do this to

minimize the risk of wastage of product.

Conceptual Framework
 CHAPTER 3

METHODOLOGY

Research Design

The researchers will use a qualitative research approach, focusing solely on

qualitative methods to gather and analyze data. Qualitative research involves employing

techniques such as interviews, observations, or content analysis to explore and understand

the efficiency of the FIFO method on rising prices thoroughly. To ensure the study’s

quality, the researchers will select individuals knowledgeable about inventory

management and pricing. The researchers will conduct interviews and analyze the data to

comprehend how effective and efficient FIFO method on rising prices.

Population and Sample

The population of this study will be the selected merchandising businesses

in Brgy. Kaypian, San Jose Del Monte. The researchers will select respondents as a

sample population of this study based on quota sampling.

Research Instrument/s