The basis of the LIFO theory is meant to maximize the profitability and tracking of manufacturing practices. When LIFO is applied to inventory and sales figures, it means that the most recently produced products are the first to be shipped to consumer outlets. The logic behind this application is that the costs of the raw materials used in productions of company widgets will be best reflected in the price the widgets are sold based upon the products produced last.
Because of rapidly fluctuating materials costs, sales prices can reflect these fluctuations in real time. It is because of this that Six Sigma LIFO helps to make certain that profitability continues for the manufacturer. Unlike the sound of the methodology, it really does not mean that the last widget to come off the line is the first to be placed on a truck for shipment to the consumer outlet. It is more of an accounting method to help offset the erratic commodities markets and continue to sell products at profitable levels.
IRS code allows companies to write off any item or items sold at a loss or sold for a lower amount than it cost to produce it. These write offs come in the form of a capital loss. Most companies in the US operate on a last in, first out basis, but many countries around the world operate on a first in, first out basis.
Most people have difficulty in understanding how this concept will help companies save money. Basically, it helps to ensure that the cost of products sold is higher than the cost of manufacture, but the accounting method will reflect a slight loss. This loss, in turn, is used to reduce the net income, thereby reducing the entire tax liability for a company.
While many people might view this as cooking the books, it is perfectly legal. Most large companies in the US use this form of accounting to help ensure increased profitability and lowered tax liabilities.
The model of Six Sigma – Last In, First Out works especially well during times of financial uncertainty. In a recessionary, or even a depressive economy, the costs of materials and goods rise. Using this method of accounting, manufacturers will be able to show a net gain for products that are sold at a slight loss due to the reduced taxable liabilities for the widget.
In an inflationary economy that is being held in check, a manufacturer's taxable liability will likely increase by using this method. Fortunately, inflation has not been held in check for many years despite what the pundits allow. Real world tracking of inflation has shown that the US dollar has declined by 50% in value in the ten years between 2000 and 2011. Six Sigma LIFO is one way to counteract this.