Question 5 In A Period Of Rising Prices FIFO Will Have Lower

Question 5in A Period Of Rising Prices Fifo Will Havelower Net Purcha

Question 5 In a period of rising prices, FIFO will have lower net purchases than LIFO. lower income tax expense than LIFO. lower net income than LIFO. lower cost of goods sold than LIFO.

Paper For Above instruction

In periods of rising prices, the choice of inventory valuation method significantly impacts financial statements and tax obligations. The two predominant methods, FIFO (First-In, First-Out) and LIFO (Last-In, First-Out), differ in how they account for inventory costs, leading to various financial implications during inflationary times.

FIFO assumes that the earliest goods purchased are sold first. During inflation, this results in lower cost of goods sold (COGS) because older, cheaper inventory is expensed first, leading to higher gross profit and net income. Conversely, LIFO assumes that the most recent inventory costs are recognized first, which during inflation results in higher COGS, lower net income, and potentially lower taxable income.

Considering the statements in the question:

  • The assertion that FIFO will have lower net purchases than LIFO during inflation is generally false, because net purchases are determined by the purchase activity regardless of inventory accounting methods. The method influences COGS and income statements, not the purchasing volume directly.
  • Focusing on income tax expenses, FIFO results in higher net income during inflation, which leads to higher taxable income and thus potentially higher income tax expense compared to LIFO.
  • Regarding net income, FIFO tends to report higher net income than LIFO in inflating environments, contrary to the statement that FIFO would have lower net income.
  • Finally, because COGS under FIFO is lower than under LIFO in rising prices, the gross profit and net income are correspondingly higher under FIFO, and the cost of goods sold is lower, matching the statement that FIFO has lower COGS than LIFO.

In conclusion, in a rising price environment, FIFO generally results in higher net income and higher income tax expense compared to LIFO, and lower COGS. The impact on net purchases depends on the purchasing activity, not the inventory valuation method directly.

References for above analysis

  • Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Financial Accounting (10th ed.). Wiley.
  • Gibson, C. H. (2017). Financial Reporting & Analysis (14th ed.). Cengage Learning.
  • Horngren, C. T., Datar, S. M., & Rajan, M. (2019). Cost Accounting: A Managerial Emphasis (16th ed.). Pearson.
  • Heisinger, K. & Hoyle, J. (2017). Wholesale Accounting Principles. South Western College Publishing.
  • Wild, J. J., Subramanyam, K. R., & Halsey, R. F. (2014). Financial Statement Analysis (11th ed.). McGraw-Hill Education.
  • Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial Accounting Theory and Analysis. Wiley.
  • Accountancy, A. G. (2020). Understanding Inventory Costing Methods. Journal of Accountancy.
  • Muslim, A., & Sulaiman, R. (2019). Impact of Inventory Valuation Methods on Financial Performance. International Journal of Accounting and Financial Reporting.
  • Revsine, L., Collins, D., Johnson, W., & Mittelstaedt, F. (2015). Financial Reporting and Analysis. Pearson.
  • American Institute of CPAs (AICPA). (2020). Principles of Inventory Management. AICPA Publications.

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