Question

A company may purchase a portion of its inventory at different prices over time. For example it may purchase one shipment at $10 per unit and another shipment at $15 per unit later in the year. When the company then subsequently sells some of the inventory (e.g. $20 per unit), GAAP requires the company to be consistent in the method used for inventory costing What financial statement impact (i.e. balance sheet & income statement) would you anticipate if the company selects a method that treats the units sold as coming from the first shipment instead of the second shipment? Would this accounting choice be something the CEO/CFO may want to do if they were permitted to do so?

Answer 1

If the units sold are treated as coming from the first shipment instead of the second shipment (i.e. First-In, First-Out basis), on the income statement, the cost of the goods sold would be valued at $10 per unit instead of $15 per unit and hence would be lower, thereby resulting in a higher net income.

On the balance sheet, the ending inventory would be higher as also the retained earnings.

The higher net income would result in higher income taxes however, the CEO/CFO may want to do this if they were looking for external financing from a bank in order to show higher profits.