If a company uses FIFO for inventory valuation, how will rising prices affect the financial statements?
Practice Questions
1 question
Q1
If a company uses FIFO for inventory valuation, how will rising prices affect the financial statements?
Higher ending inventory and lower cost of goods sold
Lower ending inventory and higher cost of goods sold
No effect on financial statements
Higher cost of goods sold and lower net income
Under FIFO, in times of rising prices, the ending inventory will be higher and the cost of goods sold will be lower.
Questions & Step-by-step Solutions
1 item
Q
Q: If a company uses FIFO for inventory valuation, how will rising prices affect the financial statements?
Solution: Under FIFO, in times of rising prices, the ending inventory will be higher and the cost of goods sold will be lower.
Steps: 5
Step 1: Understand FIFO - FIFO stands for 'First In, First Out'. This means that the oldest inventory items are sold first.
Step 2: Recognize rising prices - When prices are rising, the cost of new inventory is higher than the cost of older inventory.
Step 3: Determine ending inventory - Under FIFO, the ending inventory consists of the most recently purchased (and therefore more expensive) items, which means the ending inventory value will be higher.
Step 4: Calculate cost of goods sold (COGS) - Since the oldest (and cheaper) inventory is sold first, the cost of goods sold will be based on these lower costs, making COGS lower.
Step 5: Impact on financial statements - Higher ending inventory increases total assets on the balance sheet, while lower COGS increases net income on the income statement.
