What is the impact of switching from FIFO to LIFO on a company's financial statements during a period of rising prices?
Practice Questions
1 question
Q1
What is the impact of switching from FIFO to LIFO on a company's financial statements during a period of rising prices?
Increase in net income.
Decrease in net income.
No impact on net income.
Increase in cash flow.
Switching from FIFO to LIFO during inflation will typically decrease net income due to higher COGS being reported.
Questions & Step-by-step Solutions
1 item
Q
Q: What is the impact of switching from FIFO to LIFO on a company's financial statements during a period of rising prices?
Solution: Switching from FIFO to LIFO during inflation will typically decrease net income due to higher COGS being reported.
Steps: 6
Step 1: Understand FIFO and LIFO. FIFO (First In, First Out) means the oldest inventory costs are used first when calculating the cost of goods sold (COGS). LIFO (Last In, First Out) means the newest inventory costs are used first.
Step 2: Recognize the impact of rising prices. When prices are rising, the cost of new inventory is higher than the cost of older inventory.
Step 3: Calculate COGS under FIFO. Using FIFO, the COGS will be lower because it uses the older, cheaper inventory costs.
Step 4: Calculate COGS under LIFO. Using LIFO, the COGS will be higher because it uses the newer, more expensive inventory costs.
Step 5: Compare net income. With higher COGS under LIFO, the net income will be lower compared to FIFO during periods of rising prices.
Step 6: Understand the overall impact. Lower net income can affect taxes and financial ratios, making the company appear less profitable.
