In a case study, a company switched from FIFO to LIFO. What immediate effect would this have on their financial statements?
Practice Questions
1 question
Q1
In a case study, a company switched from FIFO to LIFO. What immediate effect would this have on their financial statements?
Increase in net income.
Decrease in net income.
No effect on net income.
Increase in cash flow.
Switching to LIFO during inflation would decrease net income due to higher cost of goods sold.
Questions & Step-by-step Solutions
1 item
Q
Q: In a case study, a company switched from FIFO to LIFO. What immediate effect would this have on their financial statements?
Solution: Switching to LIFO during inflation would decrease net income due to higher cost of goods sold.
Steps: 5
Step 1: Understand FIFO and LIFO. FIFO (First In, First Out) means the oldest inventory costs are used first, while LIFO (Last In, First Out) means the newest inventory costs are used first.
Step 2: Recognize the impact of inflation. When prices are rising (inflation), the cost of newer inventory is higher than older inventory.
Step 3: Calculate Cost of Goods Sold (COGS) under LIFO. Since LIFO uses the higher costs of newer inventory, COGS will increase.
Step 4: Determine the effect on net income. Higher COGS means lower net income because expenses are higher.
Step 5: Review the financial statements. The income statement will show lower net income, and the balance sheet may reflect lower retained earnings.
