![]() ![]() It will prefer FIFO to report higher inventory levels and thus show “more” assets to lenders and shareholders. The company will prefer LIFO to reduce taxes. The corporation cannot go back and forth from one method to the other as the wind blows. To switch to LIFO, the firm must complete IRS Form 970. Companies pay higher taxes when profits are higher, as might be the case using FIFO, assuming all else equal. When corporations expect high inflation (as occurred in the 1970s and in the early 2020s), many will switch to LIFO in order to reduce taxes. In an inflationary environment, taxes payable will therefore be lower.Īssuming inventory costs rise as often happens when there is inflation, FIFO will always produce a higher gross profit. Again, the two numbers add up to the sum of the inventory cost: $100 + 900 = $1,000. The ending inventory will be the first unit acquired, costing $100. Therefore, we add in reverse chronological order: $300 + 250 + 200 + 150 = $900. Under LIFO, we must take the last-in, first-out order to compute the sum of the units sold and to arrive at the COGS number. Notice that $700 + 300 = $1,000 or the entire inventory cost. This left $300 in the ending inventory on the balance sheet. The income statement will show a $700 COGS number as a deduction from sales to arrive at the gross profit of $2,000 – 700 = $1,300. So, the cost of goods sold (COGS) figure was the sum of the first four (since four units were sold) costs: $100 + 150 + 200 + 250 = $700. Under FIFO, the first- in were assumed to be the first- out. For every sale, there is an invoice, and the dollar amount is not at all subject to any choice of accounting inventory costing method. 3.9 Inventory Costing Calculations: A Closer Look at the COGS and Ending Inventory Computationsįirst, it must be recognized that the sales amount is independent of any costing method. ![]()
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