Final answer:
Companies use LIFO for tax purposes to lower taxes during inflation and FIFO for internal reporting to more accurately reflect current costs and profitability. This dual approach allows for tax savings while maintaining informed internal financial decisions.
Step-by-step explanation:
Reasons for Using Different Inventory Accounting Methods
Companies may opt to use LIFO (Last-In, First-Out) for tax and general purpose financial statements while employing FIFO (First-In, First-Out) for internal reports due to several strategic reasons. For tax purposes, using LIFO might result in lower taxable income during periods of rising prices, as the cost of goods sold (COGS) would be higher when the last acquired, more expensive, inventory items are considered sold first. This can lead to tax savings. In contrast, for internal purposes, FIFO can provide a better approximation of current inventory costs and more accurate profit margins, helping with budgeting and forecasting. This bifurcated approach allows businesses to gain tax advantages without skewing the internal financial analysis and decision-making processes.
For instance, during inflationary times, LIFO will increase COGS, reducing reported net income and thus, deferring income tax liability. However, internally, using FIFO, which reports lower COGS, may offer management a clearer view of the actual increase in inventory costs and how it affects the company's profitability. The use of FIFO internally can also align more closely with the actual physical flow of goods in many inventory scenarios.
In conclusion, a company may use LIFO for tax reporting to reduce tax burdens during periods of inflation, while FIFO is used internally for its more realistic representation of current costs and profit measures.