Which inventory method is going to yield the highest net income in a period of rising costs?
Your company has three inventory costing methods from which to choose. The choice is important because it influences your cost of goods sold, net income and income tax payable. Whichever method you choose, accounting rules call for you to stick with it; the Internal Revenue Service might not allow you to flip-flop your accounting method just to take advantage of the latest price trend. Show Last-in, first-out, or LIFO, uses the most recent costs first. When prices are rising, you prefer LIFO because it gives you the highest cost of goods sold and the lowest taxable income. First-in, first-out, or FIFO, applies the earliest costs first. In rising markets, FIFO yields the lowest cost of goods sold and the highest taxable income. If you sell one-of-a-kind items like custom jewelry, you might prefer the specific identification method. You record the cost of each item, so the cost of goods sold doesn’t require as much fancy math. When you use the periodic, or book, inventory system, you value your inventory at specific intervals and lump together the results. For example, suppose you purchase 10 items at $100 each on the first of the month. On the 14th, you sell six items and on the 16th buy another 10 for $120 each. You sell eight items on the 19th and buy another 10 on the 23rd for $130 each. On the last day of the month, you sell nine items. Under periodic inventory LIFO, your cost of goods sold is the sum of 10 items times $130, 10 items times $120 and three items times $100. This adds up to $2,800, and you value your remaining inventory at $700. In the perpetual inventory system, you figure the cost at the time of each sale instead of at specific intervals. Your cost of goods sold on the 14th is six items times $100, or $600. The sale on the 19th costs $120 times eight units, or $960. The last sale costs $130 times nine items, or $1,170. Notice that each sale uses the latest item cost, which simplifies the math. The total cost is $2,730, or $70 less than the cost under the periodic inventory method. Your remaining inventory tallies in at $770. Your taxable income is $70 less using the periodic inventory system. If you are in the 25 percent bracket, this translates into a tax savings of $17.50. Since prices always seem to increase over time, LIFO is a good bet for consistently maximizing your cost of goods sold. The example deals with a retail situation but also applies to product manufacturers. However, if you manufacture products using raw materials that fluctuate in price, such as petroleum, you may not always benefit from the LIFO method. The IRS lets you initially choose your inventory accounting method but wants you to use it consistently year to year. If you choose LIFO, you must file IRS Form 970 in the first year you use this method. If you want to change methods, you might need to ask for IRS approval by filing Form 3115. There are two basic issues of inventory accounting:
Practice Question 1What does the FIFO inventory method assume about the first units purchased? A. They are the first units sold. B. They are the units that remain in ending inventory.C. They are the only units used in computing average cost. Correct Answer: A FIFO treats the first units purchased as though they are the first unit sold.Practice Question 2When calculating ending inventory using the average cost method, which of the following is CORRECT? A. The numerator is the beginning inventory balance plus purchases. B. The denominator is the number of units remaining.C. The denominator is the number of units purchased. Correct Answer: A The average cost is calculated by taking the beginning inventory balance plus purchases divided by the total number of units in inventory, which is the number in the beginning balance plus the number purchased.Practice Question 3SportsTrader began operations on January 1, 2006. It has been using FIFO since then for inventory accounting. The following stock record card for footballs was taken from the records at the end of 2011.
C. $595. Correct Answer: B 10 x $20 + 20 x $22 = $640.Practice Question 4Which of the following results from using the LIFO method of inventory cost flows during a period of inflation? A. understated cost of goods sold. B. overvalued inventory. C. currently valued cost of goods sold.D. currently valued inventory. Correct Answer: C LIFO matches current costs with current revenues. During a period of inflation, LIFO results in currently valued cost of goods sold.Practice Question 5Which inventory method generally results in costs allocated to ending inventory that will approximate current costs? A. LIFO B. FIFOC. average cost method Correct Answer: B FIFO allocates the most recent costs to inventory.Practice Question 6Under U.S. GAAP, a company that uses the LIFO method to compute taxable income must use the ______ method for financial reporting. A. FIFO B. average costC. LIFO Correct Answer: C The tax law requires a company that uses LIFO for tax purposes also use LIFO for financial reporting purposes.Practice Question 7Under which cost flow assumption is the ending inventory composed of the earliest purchased merchandise? A. FIFO B. LIFOC. Average Cost Correct Answer: B Under the LIFO (Last-In, First-Out) cost flow assumption, inventory is sold from the most recent purchases, leaving the earliest purchased inventory on hand.Practice Question 8If inventory costs remain relatively constant from period to period, which inventory method is the most appropriate one in the allocation of cost flow between COGS and inventory carrying value? I. Specific identification method. II. FIFO. III. Weighted average method.IV. LIFO. Correct Answer: All of them Given relatively constant prices, the allocation of costs between COGS and ending inventory would be very similar under each of the four methods.Practice Question 9Which methods are based on cost flow assumptions? I. Specific identification. II. FIFO. III. LIFO.IV. Weighted Average Cost. Correct Answer: II, III and IV I is based on physical flow. The flow of costs does not have to correspond with the physical flow of units. The costs can flow differently than the goods. In other words, if a firm uses LIFO, it may sell the oldest (first) item to a customer, but can report the cost of goods sold of the price of the last purchase.Practice Question 10Which inventory valuation method is not permitted under IFRS? A. LIFO. B. FIFO.C. Specific Identification. Correct Answer: A LIFO is permitted only under U.S. GAAP.Practice Question 11Beginning inventory 10 units @ $5 per unit First sale 4 units First purchase 10 units @ $6 per unit Second purchase 12 units @ $7 per unitSecond Sale 20 units What is the value of the ending inventory, using a perpetual inventory system and a FIFO cost flow assumption? A. $26 B. $36C. $56 Correct Answer: C Only 8 units remain after the second sale. On a FIFO perpetual basis, the 8 units will be assigned the most recent purchase price of $7 ($7 x 8 = $56).Practice Question 12Beginning inventory 10 units @ $10 per unit First purchase 35 units @ $11 per unit Second purchase 40 units @ $12 per unitThird purchase 15 units @ $13 per unit If 83 units are sold, what is the value of the ending inventory under a periodic inventory system and a FIFO cost flow assumption? A. $219 B. $905C. $177 Correct Answer: A The ending inventory (17 units) would be composed of the most recent purchases (newest layers) of 15 X $13 plus 2 X $12, or $195 + $24.Practice Question 13Which inventory cost flow assumption normally will yield the highest cost of goods sold during a period of declining prices? A. weighted average B. FIFOC. LIFO Correct Answer: B The older, higher inventory purchases will be the costs that go into cost of goods sold under FIFO.Practice Question 14Zealous Ltd. and Eager Ltd. are identical companies in every respect except that Zealous uses the LIFO method for inventory costing while Eager uses FIFO costing. The companies operate in an industry in which costs have been increasing over the past several years. Compared to Zealous, which of the following could be said about Eager? A. Eager has a lower earnings per share. B. Eager has a higher cost of goods sold. C. Eager has a lower ending inventory.D. Eager has higher total assets. Correct Answer: D If prices are increasing, FIFO would provide higher ending inventory, since the goods on hand would be recorded at the most recent purchase prices.Practice Question 15Which of the following is an advantage of LIFO inventory valuation over FIFO during periods of falling prices (assuming not all inventory is sold)? A. Ending inventory on the balance sheet is reported at its current replacement cost. B. Tax savings associated with lower reported earnings C. It more closely adheres to the matching principle.D. It more closely parallels the physical flow of goods sold. Correct Answer: C LIFO costing uses the most recent costs to compute cost of goods sold. Assuming costs are changing, these costs more closely match a firm's revenue, which is usually matching the trend of cost changes.Practice Question 16In a period of declining prices, which of the following statements would be true? A. LIFO would produce higher gross profit margin percentages than would average costs. B. FIFO would produce higher gross profit margin percentages than would LIFO. C. Average costs would produce higher gross profit margin percentages than would LIFO.D. FIFO would produce higher gross profit margin percentages than would average costs. Correct Answer: A If prices are declining, LIFO would provide lower cost of goods sold, since lower costs would be allocated to the items sold.Practice Question 17Prices have been rising during the past few years. Companies Ashley and Taylor are in the same industry and use the same accounting methods except for inventory valuation. Ashley uses FIFO, and Taylor uses LIFO. Which of the following statements is true? A. The inventory on Taylor's books closely approximates current market prices B. The cost of goods sold for Taylor more closely approximates current replacement valuesC. The inventory for Taylor and Ashley are the same Practice Question 18Which of the following is true in periods of rising prices? A. Working capital under FIFO will appear to be better than under LIFO. B. Cash flows under FIFO will be better than LIFO.C. Cash flows will be the same under FIFO and LIFO. Correct Answer: A The inventory under FIFO will be much higher than the inventory under LIFO. While cash flows will be lower (due to the tax differences), the effect on the inventory is usually greater; thus the working capital under FIFO will appear to be better even though cash flows under LIFO are better.Practice Question 19Which of the following statements is (are) true under U.S. GAAP? I. If a LIFO inventory layer is depleted in one period, it can always be replenished by an identical layer in the next period II. In periods of rising prices, cost of goods sold under LIFO will be greater than under FIFO III. The use of LIFO increases inventory holding profits during periods of rising pricesIV. A company may use LIFO inventory procedures for tax purposes and another cost method for financial reporting purposes Correct Answer: II When LIFO is used in a period of rising prices, the latest and higher costs will go into cost of goods sold. When FIFO is used in a period of rising prices, the older and lower costs will go into costs of goods sold. IV is false. Under the �LIFO conformity rule,� the U.S. tax code requires that companies using the LIFO method for tax purposes must also use the LIFO method for financial reporting.Practice Question 20Which of the following statements is true in a period of rising prices? A. The use of FIFO will lead to a useful inventory turnover B. The use of FIFO will tend to understate income C. The use of FIFO will tend to understate the debt-to-equity ratioD. The use of FIFO will improve cash flows Correct Answer: C The use of FIFO will generate a lower cost of goods sold, because the earlier, lower costs will be included in cost of goods sold. The lower cost of goods sold will result in a higher income. The higher income will be included in stockholders' equity, which will cause the debt-to-equity ratio to be lower.Practice Question 21Which of the following statements is true in an inflationary environment? A. Under FIFO, income will tend to be understated B. Under LIFO, working capital may be distorted C. Under FIFO, cash flows will be increasedD. The use of FIFO will cause debt-to-equity ratios to be overstated Correct Answer: B When LIFO is used, inventory shown under current assets will be very low, as it will be using older, lower costs. While cash flows will be higher under LIFO, the increase in cash flows is usually not enough to counteract the effect of the low inventory, and thus working capital will tend to be lower under LIFO.Practice Question 22When price levels have been increasing throughout the period, a company using the LIFO inventory valuation method instead of the FIFO inventory valuation method would have: A. higher equities B. lower net incomeC. higher net income Correct Answer: B In a period of rising prices, LIFO will yield a lower income because its cost of goods sold is higher, since it uses newer, and higher, costs.Practice Question 23During a period of rising prices, which of the following is lower using FIFO rather than LIFO? A. Income before tax. B. Income tax. C. Cost of goods sold.D. Net income. Correct Answer: CPractice Question 24Assume that prices are rising and inventories balances are increasing, which method will generate the highest cash flow? A. Average cost. B. LIFO.C. FIFO. Correct Answer: B As long as the price level increases and inventory quantities do not decrease, a deferral of income tax occurs, thus generating higher cash flows (tax must be paid in cash).Practice Question 25During a time of increasing inventory and rising prices, FIFO will result in ______ than LIFO. A. higher COGS B. higher taxes C. lower net incomeD. lower working capital Correct Answer: BPractice Question 26During a time of increasing inventory and rising prices, LIFO will result in ______ than FIFO. A. higher inventory balance B. higher taxes C. higher COGSD. higher net income Correct Answer: CPractice Question 27An inventory write-down has a positive effect on: A. liquidity ratios. B. profitability ratios.C. activity ratios. Correct Answer: C Activity ratios such as inventory turnover will be positively affected because the asset base (denominator) is reduced.Practice Question 28Diane Corporation had 400 units of inventory on hand at July 1, 2011, costing $20 each. Purchases and sales of goods during the month of July were as follows: July 12, 2011 Sales 200 units @ $40 July 15, 2011 Purchases 100 units @ $26 July 25, 2011 Purchases 300 units @ $28July 30, 2011 Sales 200 units @ $40 Assume Diane Corporation does not maintain perpetual inventory records. According to a physical count, 400 units were on hand on July 31, 2011. The cost of ending inventory using the FIFO cost method is: A. $11,000 B. $9,000C. $8,000 Correct Answer: AThe cost of inventory is the ending inventory value on the balance sheet on July 31, 2011. Using FIFO, the costs allocated to ending inventory will be the most recent costs. Therefore, if 400 units are remaining, the ending inventory value will be 300 @$28 + 100 @$26. Practice Question 29Diane Corporation had 400 units of inventory on hand at July 1, 2011, costing $20 each. Purchases and sales of goods during the month of July were as follows: July 12, 2011 Sales 200 units @ $40 July 15, 2011 Purchases 100 units @ $26 July 25, 2011 Purchases 300 units @ $28July 30, 2011 Sales 200 units @ $40 Assume Diane Corporation does not maintain perpetual inventory records. According to a physical count, 400 units were on hand on July 31, 2011. The cost of inventory at July 31, 2011, using the LIFO cost method, is: A. $11,000 B. $8,000C. $9,500 Correct Answer: BUsing LIFO, the costs allocated to ending inventory will be the oldest costs. Therefore, if 400 units are remaining, the ending inventory value will be 400 @ $20 = $8,000. Practice Question 30If companies have identical inventoriable costs, but use different inventory flow assumptions when the price of goods has not been constant, then the: A. net income of the companies will be identical. B. ending inventory of the companies will be identical.C. cost of goods available for sale of the companies will be identical. Correct Answer: CThe cost of goods available for sale will be the same if beginning inventory and purchases are the same, but if different methods are used, cost of goods sold and net income will be different, as different methods give a different value for ending inventory. Practice Question 31Which of the following flow assumptions is not acceptable under generally accepted accounting principles? A. FIFO/LIFO. B. Next-in, first-out.C. Average cost. Correct Answer: BPractice Question 32Which statement(s) is (are) true? I Under the FIFO method of inventory valuation, the assignment of costs to merchandise sold is in the same order in which the merchandise was purchased. II. The FIFO method of inventory valuation is based on an assumption that the most recent costs incurred should be charged against current-year revenues. III. The FIFO method of inventory valuation is based on the assumption that costs should be charged against revenues in the same order in which the costs were incurred.IV. LIFO is considered the most conservative inventory pricing method. A. I, II and III B. I, II and IVC. I, III and IV Correct Answer: CI. FIFO means 'first-in, first-out'--the first items purchased are the first items sold. Inventory costs are assigned to the merchandise sold in the same order in which the purchases of merchandise were made. II. Under FIFO, costs are charged in the order in which they occur, but the most recent inventory costs (purchases) are assigned to ending inventory. Inventory does not become a 'cost' until it is sold. III. FIFO means 'first-in, first-out', in other words, the cost of the first items purchased become the cost of the first items sold. IV. With a LIFO pricing system the inventory is valued at the oldest costs (usually the lowest because of inflation) and the values of the recent purchases (slightly higher costs) are assigned to the cost of goods sold. With higher costs of goods there will be a lower net income. Practice Question 33Under which cost flow assumption is the ending inventory composed of the most recently purchased merchandise? A. FIFO. B. LIFO.C. Average Cost. Correct Answer: AUnder the FIFO (First-In, First-Out) cost flow assumption, the inventory on hand is considered to be composed of the most recent items purchased. Practice Question 34Which of the following statements related to the LIFO method of inventory valuation is false? A. Despite the many benefits of LIFO, it is used by fewer U.S. companies than both FIFO and weighted average. B. The LIFO conformity rule is a tax ruling prohibiting the use of LIFO for tax purposes unless it is also used for external financial reporting purposes.C. Under LIFO, companies can manage earnings at the end of an accounting period by purchasing additional inventory. Correct Answer: ALIFO is more commonly used than weighted average for inventory valuation purposes. Practice Question 35Every-Day Clothing had a November 1 merchandise inventory balance of $45,000. It made purchases of $80,000 and recorded sales of $130,000, during November. Its estimated gross profit on sales was 25%. On November 30, the store was destroyed by fire. What was the value of the merchandise inventory loss? A. $ 27,500 B. $125,000C. $ 97,500 Correct Answer: AThe cost of goods sold is equal to sales less the gross profit on sales, or $97,500 ($130,000 X (1 -.25)). The lost inventory will be estimated as inventory available at cost less the cost of goods sold. Practice Question 36The goods available for sale, at retail prices, total $200,000. If the cost ratio for the period totals 60%, and the net sales at retail for the period total $120,000, what is the ending inventory at cost? A. $ 48,000 B. $ 24,000C. $ 72,000 Correct Answer: AReducing total goods available for sale at retail ($200,000) by sales at retail ($120,000) leaves a remainder (ending inventory at retail) of $80,000. If the cost of the ending inventory is 60% of ending inventory at retail value, the cost of the ending inventory at cost is $48,000 ($80,000 x 60%). Practice Question 37Czech Ltd. shipped goods to a customer on December 30, 2010. Since Czech used the shipping company requested by the customer, the customer took the risk of the goods not being delivered by the shipping company. The customer received the goods on January 6, 2011. The selling price of the goods was $57,000. The sale was recorded by Czech on January 2, 2011. Czech had paid $42,000 for the goods and used the periodic method to account for its inventory. Which of the following statements with respect to this transaction is true? A. Income for 2010 is understated by $42,000. B. Income for 2011 is overstated by $15,000.C. Revenues for 2010 are understated by $57,000. Correct Answer: CThe revenue should be recorded in 2010 since the goods were shipped before the year end. Practice Question 38Greenbelt Processors had a beginning inventory of 798 units valued at a cost of 34,895. It purchased 4,474 units of new inventory worth 195,402 during the year. A year-end audit revealed that it had 853 units on hand. If Greenbelt uses the FIFO method, what was its COGS for the year? A. 193,000 B. 193,042C. 193,027 Correct Answer: BSince Greenbelt has 853 units on hand at year-end, under FIFO they all belong to purchases made during the year. Unit price of purchases = 195,402 / 4,474 = 43.675 Ending inventory = 853 x 43.675 = 37,255COGS = BI + Purchases - EI = 34,895 + 195,402 - 37,255 = 193,042. Practice Question 39Greenbelt Processors had a beginning inventory of 798 units valued at a cost of 34,895. It purchased 4,474 units of new inventory worth 195,402 during the year. A year-end audit revealed that it had 853 units on hand. If Greenbelt uses the weighted average cost method, what was its COGS for the year? A. 193,000 B. 193,027C. 193,035 Correct Answer: CUnder average cost method, we price all units including those in beginning inventory and purchased during the year at an average price. Average price = [34,895 + 195,402] / [798 + 4,474] = 43.683 Ending inventory = 853 x 43.683 = 37,262COGS = BI + Purchases - EI = 34,895 + 195,402 - 37,262 = 193,035. Practice Question 40Greenbelt Processors had a beginning inventory of 798 units valued at a cost of 34,895. It purchased 4,474 units of new inventory worth 195,402 during the year. A year-end audit revealed that it had 853 units on hand. If the average unit price was 43.65 at the end of the year, what COGS would Greenbelt report? A. 193,064 B. 193,035C. 193,027 Correct Answer: AIf the ending price is 43.65, which is less than all three unit prices calculated under FIFO, LIFO or Average Cost Method, the conservative principle of "lower of cost or market" needs to be applied. At this price, Ending inventory = 853 x 43.65 = 37,233COGS = BI + Purchases - EI = 34,895 + 195,402 - 37,233 = 193,064. Practice Question 41When comparing FIFO with LIFO, which of these arguments is INCORRECT (Assume rising prices.) A. FIFO more closely follows the actual physical flow of many inventory items. B. The dollar amount reported as cost of goods sold under FIFO more closely approximates current cost of goods sold.C. The dollar amount reported as ending inventory under FIFO more closely approximates the current cost of inventory. Correct Answer: BA is correct because the FIFO method more closely follows the actual physical flow of most inventory items. B is incorrect because LIFO, not FIFO, reports the more recent, higher-priced goods as cost of goods sold. C is correct because ending inventory under FIFO is comprised of the newer, higher-priced goods, which is a closer approximation of current costs. Practice Question 42Which of the following statements is not true in regard to the LIFO inventory cost flow assumption? A. The LIFO cost flow assumption does not normally reflect the usual physical flow of inventory units. B. For balance sheet purposes, the cost of inventory will approximate the current replacement cost under the LIFO assumption.C. If a company uses LIFO for tax purposes, it must also use LIFO for external financial reporting purposes. Correct Answer: BUnder LIFO, the inventory on the balance sheet will consist of older costs, usually from a previous period, and will not represent the latest costs. Practice Question 43Given equal circumstances, which inventory method is the best to use for tax purposes (assume prices are rising)? A. Average cost. B. FIFO.C. LIFO. Correct Answer: CLIFO reduces taxable income and thus reduces taxes. Practice Question 44Date Quantity Per Unit Total Cost Jan 1, Beginning Inventory 100 $18.00 $ 1,800.00 Mar 4, Purchase 400 19.00 7,600.00 May 8, Purchase 800 18.25 14,600.00 Nov 3, Purchase 500 20.40 10,200.00Merchandise Available 1,800 34,200.00 Five hundred units are unsold. Using the average cost method under a periodic inventory system, how much is the cost assigned to the ending merchandise inventory? A. $ 9,400 B. $ 9,800C. $ 9,500 Correct Answer: CUsing the average cost method, the ending inventory would be calculated as: $34,200 / 1,800 = $19 per unit cost. 500 X $19 = $9,500. Practice Question 45In periods of rising prices and stable or increasing inventory quantities, the impact of LIFO and FIFO on income before taxes is: A. LIFO results in lower income. B. FIFO results in lower income.C. The choice of LIFO vs. FIFO does not affect income. Correct Answer: ALIFO retains (earlier) lower cost inventory, thereby increasing COGS, and thereby decreasing income. FIFO results in the opposite. Practice Question 46In a period of rising prices, many firms adopt the periodic LIFO method of accounting for inventory cost for tax purposes. When compared with periodic FIFO or average cost: A. LIFO allocates older and therefore smaller inventory costs to cost of goods sold. B. LIFO allocates the newest and therefore the largest inventory costs to cost of goods sold.C. LIFO produces an inventory valuation on the balance sheet that is always closer to replacement cost. Correct Answer: BThe latest costs, which are the highest costs, will be allocated to cost of goods sold. The higher cost of goods sold will cause income before taxes to be lower, and thus income taxes will be lower. Practice Question 47Which of the following statements is true concerning the use of LIFO in a period of rising prices? A. The use of LIFO will lead to a useful working capital number and inventory turnover. B. The debt-to-equity ratio will be higher than under FIFO.C. The use of LIFO will lead to lower cash flows. Correct Answer: BWhen FIFO is used, the cost of goods sold is lower, income is higher, and retained earnings is higher. This makes the equity higher; thus the debt-to-equity ratio under FIFO will be lower than under LIFO. Practice Question 48Which of the following statements concerning inventory valuation is INCORRECT? A. LIFO is superior for income statement purposes whereas FIFO is superior for balance sheet purposes. B. In order to adjust balance sheet values for a company using LIFO, an analyst would add LIFO reserve to the reported inventory value.C. During periods of rising input prices, LIFO would underestimate gross profit. Correct Answer: CLIFO reports proper income or profit when prices are rising. FIFO would overestimate it. Practice Question 49Comparing with FIFO, LIFO results in (during periods of rising prices) A. higher COGS and higher inventory balance. B. higher COGS and lower inventory balance.C. lower COGS and higher inventory balance. Correct Answer: BPractice Question 50Comparing with FIFO, LIFO results in (during periods of rising prices) A. higher taxes and lower cash flows. B. lower taxes and higher cash flows.C. lower taxes and lower cash flows. Correct Answer: BPractice Question 51When prices are rising, comparing with LIFO, FIFO results in A. lower working capital and higher cash flows. B. higher working capital and higher cash flows.C. higher working capital and lower cash flows. Correct Answer: CPractice Question 52Comparing with LIFO, FIFO results in ______ when prices are rising. A. lower inventory balance and lower net income. B. lower inventory balance and higher net income.C. higher inventory balance and higher net income. Correct Answer: CPractice Question 53Swimsuit Shop uses FIFO inventory method. During a time of rising prices and constant inventory level (in terms of quantity), Swimsuit Shop would experience A. higher taxes. B. higher cash flows.C. higher cost of goods sold (COGS) and lower net income. Correct Answer: AThe sequence is: lower COGS --> higher net income --> higher taxes --> lower cash flows. Practice Question 54Which statement(s) is (are) FALSE? I. Under the LIFO method of inventory valuation, the ending merchandise inventory would be valued at the purchase price of the most recent purchases. II. During extended periods of rising prices, the FIFO method of inventory valuation will yield a higher cost of goods sold and a lower ending merchandise inventory, when compared to the LIFO method of inventory valuation. III. The accounting principle of consistency prohibits any changes in the method of inventory valuation.IV. JIT means just in time and is an inventory method where the raw materials for production are purchased in smaller quantities after orders have been taken for the manufactured products. A. I, II and III B. I, II and IVC. II, III and IV Correct Answer: AI. LIFO means 'last-in, first-out'--the cost of the last items purchased are charged to the most recent sales. The merchandise inventory at the end of the year is considered to be from the oldest purchases. II. The FIFO method will result in a lower cost of goods sold and a higher ending merchandise inventory (valued at first-in costs). III. While consistency should be maintained, legitimate changes are allowed. However, the nature, justification, and effect of the change on net income must be disclosed (full-disclosure principle). IV. JIT inventory systems require reliable suppliers and efficient handling and shipping of materials. Practice Question 55If ending inventory is understated by $2,000 and beginning inventory is overstated by $3,000, the net income will be A. understated by $5,000. B. overstated by $1,000.C. overstated by $5,000. Correct Answer: ACOGS = BI + Purchase - EI. If BI is higher, the COGS is higher. If EI is lower, the COGS is higher. Based on the relationship, the COGS is overstated by $2,000 + $3,000. The net income is understated by $5,000. Practice Question 56If prices of a product are falling the use of LIFO rather than FIFO will lead to: A. higher working capital and higher net income. B. higher working capital and lower net income.C. lower working capital and higher net income. Correct Answer: ACOGS will be lower under LIFO in a period of falling prices leading to higher net income and higher tax payments. Working capital will be higher since the higher inventory value will outweigh the lower cash balance due to higher tax payments. Practice Question 57An inventory write-down has a negative effect on: I. liquidity ratios. II. profitability ratios. III. activity ratios.IV. solvency ratios. A. I, II and III B. I, II and IVC. All of them Correct Answer: BAn inventory write-down will positively affect activity ratios such as inventory turnover because the asset base (denominator) is reduced. However, all other ratios will be negatively affected as both the profit and the carrying amount of inventory are reduced. Which inventory method yields the highest net income?In periods of rising prices, the fifo method yields the highest amount for ending inventory, the lowest cost of merchandise sold, and the highest net income.
Which inventory method is best for rising prices?FIFO leaves the newer, more expensive inventory in a rising-price environment, on the balance sheet. As a result, FIFO can increase net income because inventory that might be several years old–which was acquired for a lower cost–is used to value COGS.
Which one is better in periods of rising prices LIFO or FIFO?During times of inflation, COGS is higher under LIFO than under FIFO. This is because the most recently purchased items are sold first: 100 units from 2019, 100 units from 2018, and 50 units from 2017. Under FIFO, the oldest items are sold first: 100 units from 2016, 100 units from 2017, and 50 units from 2018.
Which inventory method provides the highest profit and why?The FIFO method gives you more accurate information as it assumes the older inventory items are less costly and are the ones sold first. Also, the FIFO method provides you with the highest profit as the first items in stock are often the cheapest.
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