Question

During a period of rising inventory costs and stable output prices, describe how new income and total assets would differ depending upon whether LIFO or FIFO is applied. Explain how your answer would change if the company is experiencing declining inventory costs and stable output prices.

Answer 1

When inventory cost is rising and stable output price than under:

1) FIFO, the net income will increase compared to LIFO, and the cost of ending inventory will increase, thereby increasing the total assets. As under FIFO, the merchandise purchased first are sold first so at the time of rising in prices of the inventory purchased first are of the lesser price than the list purchased later so the cost of good sold will include the stock purchased first which are at a lesser cost hence the income will increase. The merchandise purchased later is included in the ending list, which is higher than the inventory purchased earlier. Therefore ending inventory cost will increase, as ending inventory is part of current assets in the Balance sheet increase in existing assets increases the total assets.

2) LIFO, the net income will decrease compared to FIFO, and the cost of ending inventory will decrease, thereby decreasing the total assets. As under LIFO, the merchandise purchased last are sold first, so at the time of rising in prices of the inventory purchased last are of a higher price than the list purchased first, so the cost of good sold will include the stock purchased later which are at a higher cost hence the income will decrease. The merchandise purchased first is included in the ending list, which is a lesser cost than inventory purchased later. Thus, ending inventory cost will reduce, as ending inventory is part of the Balance sheet's current assets. The decrease in existing assets decreases the total assets.

When inventory cost is declining and stable output price than under:

1) FIFO, the net income will decrease compared to LIFO, and the cost of ending inventory will decrease, thereby decreasing the total assets. As under FIFO, the merchandise purchased first are sold first so at the time of decline in prices of the merchandise purchased first are of a higher price than the list purchased later so the cost of good sold will include the list purchased first which are at a higher cost hence the income will decrease. The merchandise purchased later is included in the ending list, lower than the plan purchased earlier. Therefore ending inventory cost will reduce, as the ending list is part of current assets in the Balance sheet decrease in existing assets decreases the total assets

2) LIFO, the net income will increase compared to FIFO, and the cost of ending inventory will increase, thereby increasing the total assets. As under LIFO, the merchandise purchased last are sold first, so at the time of decline in prices of the inventory purchased last are of the lesser price than the list purchased first, so the cost of good sold will include the stock purchased later, which are at a lower cost hence the income will increase. The merchandise purchased first is included in the ending list, which is higher than the inventory purchased later. Therefore ending inventory cost will increase, as ending inventory is part of current assets in the Balance sheet increase in existing assets increases the total assets.