An inventory costing also known as valuation refers to a specific accounting concept that directly impacts one’s gross profit and consequently the taxable income. For restaurants, the options for inventory techniques include First-in-Fist-out (FIFO), Last-in-First-out (LIFO) and Weighted Average Cost (WAC). By analyzing each of the methods, This paper aims, determine the best inventory costing method for a restaurant.
FIFO assumes that goods first purchased are the ones to be sold first, and thus the inventory consists only of the most recent purchases, and they are accounted for by the current cost of goods. LIFO works on the assumption that goods that were purchased last are the ones to be sold first with the current prevailing prices. This means the inventory mainly consists of the oldest goods. In the WAC method of valuation, all goods are treated the same way irrespective of when they were purchased. The total cost of the goods in the inventory is divided by the total number of units to give the WAC per unit. The method best works where the value of a single item is difficult to determine.
The FIFO method tends to preserve freshness and eliminate waste making it the best choice for restaurants. The FIFO method works excellently with short demand inventory cycle or perishable goods like the ones in the foodservice business. In a restaurant, a chef will choose to use those ingredients that were purchased earliest; those nearing their expiry date to prevent wastes. FIFO best matches this scenario. The technique guides restaurants to make use of older, theoretically low priced goods first and use the freshly purchased later. This results in lower costs of items and a higher income as a consequence. Although the method contributes to lower profit margins and even net income, it leads to a reduced tax burden.
LIFO encourages older goods to be continually stored implying that a substantial amount of goods have a higher potential of becoming obsolete prior to use. This means that, if a restaurant implements the LIFO method, there will be significant losses due to wastages as more goods spoil. The technique is however relevant when used with non-perishable goods, an aspect which is not common in restaurants. Moreover, unlike the FIFO valuation method, the LIFO technique is inconsistent when it comes to giving accurate ending inventory valuation.
From the above arguments, the FIFO valuation method is the most reliable and relevant valuation method for restaurants. I, therefore, will choose to use the First-In-First-Out valuation method in my restaurant.