Results in an old measure of the cost of ending inventory. Writes inventory down when replacement cost drops below historical cost. Jan 14 PM. Do you need an answer to a question different from the above? We want to correct this solution. Tell us more. Was the final answer of the question wrong? Were the solution steps not detailed enough? Was the language and grammar an issue?
Didn't find yours? Ask a new question Get plagiarism-free solution within 48 hours. All other things being equal, the lower the COGS, the higher the income. You figure cost of goods available for sale by adding inventory purchases for the period to beginning inventory. You can influence COGS and thus income by your choice of inventory valuation methods. If you want to minimize COGS, you must sell your lowest-cost inventory first.
Generally, wholesale prices rise over time, so the oldest inventory items are normally the least expensive. Under FIFO, you assign inventory costs in purchase date sequence. Because FIFO has you subtract the cost of your oldest -- and therefore least expensive -- inventory from sales, your gross income is higher. However, prices tend to rise over the long term, meaning that FIFO may not minimize taxes for a company.
In a rising-price environment over the long term, the older inventory items would be the cheapest, while the newer, recently purchased inventory items would be more expensive. FIFO would only minimize taxes in periods of declining prices since the older inventory items would be more expensive than the most recently purchased items. It's best to consult a tax professional before determining the best methods for reducing taxable income since there are many components that go into calculating a company's tax liability.
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Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. A company may report LIFO inventory at a fraction of its current replacement cost, especially if the historical costs are from several decades ago.
LIFO supporters contend that the increased usefulness of the income statement more than offsets the negative effect of this undervaluation of inventory on the balance sheet. The third criticism—that LIFO permits income manipulation—is also valid. Income manipulation is possible under LIFO. For example, assume that management wishes to reduce income. The company could purchase an abnormal amount of goods at current high prices near the end of the current period, with the purpose of selling the goods in the next period.
Under LIFO, these higher costs are charged to cost of goods sold in the current period, resulting in a substantial decline in reported net income. To obtain higher income, management could delay making the normal amount of purchases until the next period and thus include some of the older, lower costs in cost of goods sold.
Companies may also report an alternative inventory amount in the notes to their financial statements for comparison purposes. Advantages and disadvantages of weighted-average When a company uses the weighted-average method and prices are rising, its cost of goods sold is less than that obtained under LIFO, but more than that obtained under FIFO. Weighted-average costing takes a middle-of-the-road approach.
A company can manipulate income under the weighted-average costing method by buying or failing to buy goods near year-end. However, the averaging process reduces the effects of buying or not buying. The four inventory costing methods, specific identification, FIFO, LIFO, and weighted-average, involve assumptions about how costs flow through a business.
In some instances, assumed cost flows may correspond with the actual physical flow of goods. For example, fresh meats and dairy products must flow in a FIFO manner to avoid spoilage losses.
In contrast, firms use coal stacked in a pile in a LIFO manner because the newest units purchased are unloaded on top of the pile and sold first.
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