Information: Tangy Industries, a newly formed company, has hired you as a consul
ID: 2555906 • Letter: I
Question
Information: Tangy Industries, a newly formed company, has hired you as a consultant. The company president, John Mills, is seeking your advice as to the appropriate inventory method the company should use to value its ending inventory and cost of goods sold. Mr. Mills is only aware of the LIFO and FIFO inventory valuations. He believes that LIFO might be better for tax purposes, but speculates that FIFO has certain advantages for financial reporting to investors and creditors. Mr. Mills advises you that the company will be profitable in its first year and for the foreseeable future.
Question: What impact, if any, is there on your choice in an economic state of increasing prices? What if the price of inventory purchases decreases?
Explanation / Answer
In the FIFO method of accounting, the older costs flow from the inventory to the cost of goods sold. Thus, since the recent inventory purchased in rising price scenario shall be at a higer price. Thus, the inventory valuation shall be higher and the cost of goods sold shall be lower resulting in a higher overall profitt. If LIFO is used during inflation, the cost of goods sold shall be higher and inventory valuation shall be lower resulting in lower overall profit.
In a state of decreasing prices, under FIFO, the cost of goods sold shall be higher and inventory shall be lower. Under LIFO, the cost of goods sold shall be lower and inventory shall be higher.